Professional Documents
Culture Documents
January 2004
CONSUMER
PROTECTION
Federal and State
Agencies Face
Challenges in
Combating Predatory
Lending
GAO-04-280
a
January 2004
CONSUMER PROTECTION
While there is no universally While only one federal law—the Home Ownership and Equity Protection
accepted definition, the term Act—is specifically designed to combat predatory lending, federal agencies
“predatory lending” is used to have taken actions, sometimes jointly, under various federal consumer
characterize a range of practices, protection laws. The Federal Trade Commission (FTC) has played the most
including deception, fraud, or prominent enforcement role, filing 19 complaints and reaching multimillion
manipulation, that a mortgage
broker or lender may use to make a
dollar settlements. The Departments of Justice and Housing and Urban
loan with terms that are Development have also entered into predatory lending-related settlements,
disadvantageous to the borrower. using laws such as the Fair Housing Act and the Real Estate Settlement
No comprehensive data are Procedures Act. Federal banking regulators, including the Federal Reserve
available on the extent of these Board, report little evidence of predatory lending by the institutions they
practices, but they appear most supervise. However, the nonbank subsidiaries of financial and bank holding
likely to occur among subprime companies—financial institutions which account for a significant portion of
mortgages—those made to subprime mortgages—are subject to less federal supervision. While FTC is
borrowers with impaired credit or the primary federal enforcer of consumer protection laws for these entities,
limited incomes. GAO was asked it is a law enforcement agency that conducts targeted investigations. In
to examine actions taken by federal contrast, the Board is well equipped to routinely monitor and examine these
agencies and states to combat
predatory lending; the roles played
entities and, thus, potentially deter predatory lending activities, but has not
by the secondary market and by done so because its authority in this regard is less clear.
consumer education, mortgage
counseling, and loan disclosure As of January 2004, 25 states, as well as several localities, had passed laws to
requirements; and the impact of address predatory lending, often by restricting the terms or provisions of
predatory lending on the elderly. certain high-cost loans; however, federal banking regulators have preempted
some state laws for the institutions they supervise. Also, some states have
strengthened their regulation and licensing of mortgage lenders and brokers.
GAO suggests that Congress
consider providing the Federal The secondary market—where mortgage loans and mortgage-backed
Reserve Board with the authority securities are bought and sold—benefits borrowers by expanding credit, but
to routinely monitor and, as may facilitate predatory lending by allowing unscrupulous lenders to quickly
necessary, examine nonbank sell off loans with predatory terms. In part to avoid certain risks, secondary
mortgage lending subsidiaries of market participants perform varying degrees of “due diligence” to screen out
financial and bank holding loans with predatory terms, but may be unable to identify all such loans.
companies to ensure compliance
with federal consumer protection GAO’s review of literature and interviews with consumer and federal
laws applicable to predatory officials suggest that consumer education, mortgage counseling, and loan
lending. Congress should also disclosure requirements are useful, but may be of limited effectiveness in
consider giving the Board specific
reducing predatory lending. A variety of factors limit their effectiveness,
authority to initiate enforcement
actions under those laws against including the complexity of mortgage transactions, difficulties in reaching
these nonbank mortgage lending target audiences, and counselors’ inability to review loan documents.
subsidiaries.
While there are no comprehensive data, federal, state, and consumer
advocacy officials report that the elderly have disproportionately been
victims of predatory lending. According to these officials and relevant
www.gao.gov/cgi-bin/getrpt?GAO-04-280.
studies, older consumers may be targeted by predatory lenders because,
To view the full product, including the scope among other things, they are more likely to have substantial home equity and
and methodology, click on the link above. may have physical or cognitive impairments that make them more
For more information, contact David G. Wood
at 202-512-8678 or woodd@gao.gov.
vulnerable to an unscrupulous mortgage lender or broker.
Contents
Transmittal Letter 1
Executive Summary 3
Purpose 3
Background 3
Results in Brief 4
Principal Findings 7
Matters for Congressional Consideration 15
Agency Comments and Our Evaluation 16
Chapter 1 18
The Nature and Attributes of Predatory Lending 18
Introduction Emergence of Subprime Mortgage Market 21
The Extent of Predatory Lending Is Unknown 23
Emergence of Predatory Lending As Policy Issue 25
Objectives, Scope, and Methodology 26
Chapter 2 30
Federal Agencies Use a Variety of Laws to Address Predatory
Federal Agencies Have Lending Practices 30
Taken Steps to Address Federal Agencies Have Taken Some Enforcement Actions, but
Banking Regulators Have Focused on Guidance and Regulatory
Predatory Lending, but Changes 36
Face Challenges Jurisdictional Issues Related to Nonbank Subsidiaries Challenge
Efforts to Combat Predatory Lending 49
Conclusions 54
Matters for Congressional Consideration 55
Agency Comments and Our Evaluation 55
Chapter 3 58
States and Localities Have Addressed Predatory Lending through
States Have Enacted Legislation, Regulation, and Enforcement Actions 58
and Enforced Laws to Activities in North Carolina and Ohio Illustrate State Approaches to
Predatory Lending 63
Address Predatory Regulators Have Determined That Federal Law Preempts Some
Lending, but Some State Predatory Lending Laws, but Views on Preemption Differ
Laws Have Been 68
Preempted
Chapter 4 72
The Development of a Secondary Market for Subprime Loans Can
The Secondary Market Benefit Consumers 72
May Play a Role in The Secondary Market for Subprime Loans Can Facilitate Predatory
Lending 76
Both Facilitating and Due Diligence Can Help Purchasers Avoid Predatory Loans, but
Combating Predatory Efforts Vary among Secondary Market Participants 77
Lending Assignee Liability May Help Deter Predatory Lending but Can Also
Have Negative Unintended Consequences 82
Chapter 5 88
Many Consumer Education and Mortgage Counseling Efforts Exist,
The Usefulness of but Several Factors Limit Their Potential to Deter Predatory
Consumer Education, Lending 88
Disclosures, Even If Improved, May Be of Limited Use in Deterring
Counseling, and Predatory Lending 96
Disclosures in
Deterring Predatory
Lending May Be
Limited
Chapter 6 99
A Number of Factors Make Elderly Consumers Targets of Predatory
Elderly Consumers Lenders 99
May Be Targeted for Some Education and Enforcement Efforts Focus on Elderly
Consumers 102
Predatory Lending
Appendixes
Appendix I: FTC Enforcement Actions Related to Predatory Lending 106
Appendix II: Comments from the Board of Governors of the Federal
Reserve System 108
Appendix III: Comments from the Department of Justice 111
Appendix IV: Comments from the Department of Housing and Urban
Development 114
Appendix V: Comments from the National Credit Union
Administration 118
Abbreviations
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David G. Wood
Director, Financial Markets
and Community Investment
Purpose Each year, millions of American consumers take out mortgage loans
through mortgage brokers or lenders to purchase homes or refinance
existing mortgage loans. While the majority of these transactions are
legitimate and ultimately benefit borrowers, some have been found to be
“predatory”—that is, to contain terms and conditions that ultimately harm
borrowers. Loans with these features, often targeted at the elderly,
minorities, and low-income homeowners, can strip borrowers of home
equity built up over decades and cause them to lose their homes.
The Chair and Ranking Minority Member of the Senate Special Committee
on Aging asked GAO to examine the efforts under way to combat predatory
lending. GAO reviewed (1) federal laws related to predatory lending and
federal agencies’ efforts to enforce them, (2) actions taken by states to
address predatory lending, (3) the secondary market’s role in facilitating or
inhibiting predatory lending, (4) how consumer education, mortgage
counseling, and loan disclosures may deter predatory lending, and (5) the
relationship between predatory lending activities and elderly consumers.
The scope of this work was limited to home mortgage lending and did not
include other forms of consumer loans. To address these objectives, GAO
reviewed data and interviewed officials from federal, state, and local
agencies and from industry and consumer advocacy groups; examined
federal, state, and local laws; and reviewed relevant literature. At GAO’s
request, federal agencies identified enforcement or other actions they have
taken to address predatory lending. GAO also obtained data from publicly
available databases; the data were analyzed and found to be sufficiently
reliable for this report. Chapter 1 provides the details of the scope and
methodology of this report. The work was conducted between January
2003 and January 2004 in accordance with generally accepted government
auditing standards.
Results in Brief Federal agencies have addressed predatory lending under a variety of
federal laws, including the Home Ownership and Equity Protection Act
(HOEPA), which was an amendment to the Truth in Lending Act (TILA)
designed specifically to combat predatory lending, and other consumer
protection laws such as the Federal Trade Commission Act (FTC Act), TILA
generally, and the Real Estate Settlement Procedures Act (RESPA). The
1
Throughout this report, the terms “predatory lending” and “abusive lending” are used to
refer to such practices.
2
Information relating to state and local laws and their provisions is from a database
maintained by Butera & Andrews, a Washington, D.C., law firm that tracks predatory lending
legislation, and is current as of January 9, 2004. These laws only include state and local laws
that placed actual restrictions on lending. For example, they do not include local
ordinances that consisted solely of a resolution that condemned predatory lending.
lending laws for the institutions they regulate, stating that federally
chartered lending institutions should be required to comply with a single
uniform set of national regulations. Many state officials and consumer
advocates, however, maintain that federal preemption interferes with the
states’ ability to protect consumers.
Principal Findings
Federal Agencies Have Federal agencies and regulators have used a number of federal laws to
Taken Enforcement and combat predatory lending practices. Among the most frequently used
laws—HOEPA, the FTC Act, TILA, and RESPA—only HOEPA was
Other Actions to Address
specifically designed to address predatory lending. Enacted in 1994,
Predatory Lending, but Face HOEPA places restrictions on certain high-cost loans, including limits on
Challenges prepayment penalties and balloon payments and prohibitions against
negative amortization. However, HOEPA covers only loans that exceed
certain rate or fee triggers, and although comprehensive data are lacking, it
appears that HOEPA covers only a limited portion of all subprime loans.
The FTC Act, enacted in 1914 and amended on numerous occasions,
authorizes FTC to prohibit and take action against unfair or deceptive acts
or practices in or affecting commerce. TILA and RESPA are designed in
part to provide consumers with accurate information about the cost of
credit.
Other federal laws that have been used to address predatory lending
practices include criminal fraud statutes that prohibit certain types of fraud
sometimes used in abusive lending schemes, such as forgery and false
statements. Also, the Fair Housing Act and Equal Credit Opportunity Act—
which prohibit discrimination in housing-related transactions and the
extension of credit, respectively—have been used in cases against abusive
lenders that have targeted certain protected groups.
• DOJ, which is responsible for enforcing certain federal civil rights laws,
has filed an enforcement action on behalf of the FTC and identified two
additional enforcement actions it has taken that are related to predatory
mortgage lending practices. The statutes DOJ enforces only address
predatory lending practices when they are alleged to be discriminatory.
3
HUD’s FHA mortgage insurance program makes loans more readily available for low- and
moderate-income families by providing mortgage insurance to purchase or refinance a
home. Lending institutions such as mortgage companies and banks fund the loans.
4
These nonbank subsidiaries are owned by the financial holding companies or bank holding
companies and are not the direct operating subsidiaries of the bank itself.
Many States Have Passed In response to concerns about the growth of predatory lending and the
Laws Addressing Predatory limitations of existing laws, 25 states, the District of Columbia, and 11
localities have passed their own laws addressing predatory lending
Lending, but Federal practices, according to a database that tracks such laws. Most of these
Agencies Have Preempted laws regulate and restrict the terms and characteristics of high-cost loans—
Some Statutes that is, loans that exceed certain rate or fee thresholds. While some state
statutes follow the thresholds for covered loans established in HOEPA,
many set lower thresholds in order to cover more loans than the federal
statute. The statutes vary, but they generally cover a variety of predatory
practices, such as balloon payments and prepayment penalties, and some
include restrictions on such things as mandatory arbitration clauses that
can restrict borrowers’ ability to obtain legal redress through the courts.
The Secondary Market May In 2002, an estimated 63 percent of subprime loans, worth $134 billion,
Benefit Consumers but Can were securitized and sold on the secondary market.5 The existence of a
secondary market for subprime loans has benefited consumers by
Also Facilitate Predatory
increasing the sources of funds available to subprime lenders, potentially
Lending lowering interest rates and origination costs for subprime loans. However,
the secondary market may also inadvertently facilitate predatory lending
by providing a source of funds for unscrupulous originators, allowing them
to quickly sell off loans with predatory terms. Further, originators of
subprime mortgage loans generally make their profits from high origination
fees, and the existence of a secondary market may reduce the incentive for
these lenders to ensure that borrowers can repay.
5
Originators of mortgage loans—which can include banks, other depository institutions, and
mortgage lenders that are not depository institutions—may keep the loans or sell them on
the secondary market. Secondary market purchasers may then hold the loans or pool
together a group of loans and issue a security that is backed by a pool of mortgages (a
“mortgage-backed security”).
The Usefulness of In response to widespread concern about low levels of financial literacy
Consumer Education, among consumers, federal agencies have conducted and funded financial
education for consumers as a means of improving consumers’ financial
Counseling, and Disclosures
literacy and, in some cases, raising consumers’ awareness of predatory
in Deterring Predatory lending practices. For example, FDIC sponsors a financial literacy
Lending May Be Limited program, MoneySmart, which is designed for low- and moderate-income
individuals with little banking experience. Other federal agencies,
including the Board, FTC, HUD, and OTS, engage in activities such as
distributing educational literature, working with community groups, and
Predatory Lenders May Consistent observational and anecdotal evidence, along with some limited
Target Elderly Consumers data, indicates that, for a variety of reasons, elderly homeowners are
disproportionately the targets of predatory lending. Abusive lenders tend
to target homeowners who have substantial equity in their homes, as many
older homeowners do. In addition, some brokers and lenders aggressively
market home equity loans as a source of cash, particularly for older
homeowners who may have limited incomes but require funds for major
home repairs or medical expenses. Moreover, diseases and physical
impairments associated with aging—such as declining vision, hearing, or
mobility—can restrict elderly consumers’ ability to access financial
information and compare credit terms. Some older persons may also have
diminished cognitive capacity, which can impair their ability to
comprehend and make informed judgments on financial issues. Finally,
several advocacy groups have noted that some elderly people lack social
and family support systems, potentially increasing their susceptibility to
unscrupulous lenders who may market loans by making home visits or
offering other personal contact.
Justice Department offers on its Web site the guide “Financial Crimes
Against the Elderly,” which includes references to predatory lending. The
Department of Health and Human Services’ Administration on Aging
provides grants to state and nonprofit agencies for programs aimed at
preventing elder abuse, including predatory lending practices targeting
older consumers. The AARP, which represents Americans age 50 and over,
sponsors a number of financial education efforts, including a borrower’s kit
that contains tips for avoiding predatory lending.
Consumer protection and fair lending laws that have been used to address
predatory lending do not generally have provisions specific to elderly
persons, although the Equal Credit Opportunity Act does prohibit unlawful
discrimination on the basis of age in connection with any aspect of a credit
transaction. Federal and state enforcement actions and private class-
action lawsuits involving predatory lending generally seek to provide
redress to large groups of consumers. Little comprehensive data exist on
the age of consumers involved in these actions, but a few cases have
involved allegations of predatory lending targeting elderly borrowers. For
example, FTC, six states, AARP, and private plaintiffs settled a case with
First Alliance Mortgage Company in March 2002 for more than $60 million.
An estimated 28 percent of the 8,712 borrowers represented in the class-
action suit were elderly. The company was accused of using
misrepresentation and unfair and deceptive practices to lure senior citizens
and those with poor credit histories into entering into abusive loans. In
addition, some nonprofit groups—such as the AARP Foundation Litigation,
the National Consumer Law Center, and South Brooklyn Legal Services’
Foreclosure Prevention Project—provide legal services that focus, in part,
on helping elderly victims of predatory lending.
Matters for To enable greater oversight of and potentially deter predatory lending from
occurring at certain nonbank lenders, Congress should consider making
Congressional appropriate statutory changes to grant the Board of Governors of the
Consideration Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of financial
and bank holding companies for compliance with federal consumer
protection laws applicable to predatory lending practices. Also, Congress
should consider giving the Board specific authority to initiate enforcement
actions under those laws against these nonbank mortgage lending
subsidiaries.
Agency Comments and GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
Our Evaluation comment. The agencies provided technical comments that have been
incorporated where appropriate. In addition, the Board, DOJ, FDIC, FTC,
HUD, and NCUA provided general comments, which are discussed in
greater detail at the end of chapter 2. The written comments of the Board,
DOJ, HUD, and NCUA are printed in appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as different
supervisory schemes being applied to nonbank mortgage lenders based on
whether or not they are part of a holding company, and additional costs.
Because nonbank mortgage lenders that are part of a financial or bank
holding company currently can be examined by the Board in some
circumstances, they are already subject to a different supervisory scheme
than other such lenders. We agree that the costs to the lenders and the
Board would increase to the extent the Board exercised any additional
authority to monitor and examine nonbank lenders, and believe that
Congress should consider both the potential costs and benefits of clarifying
the Board’s authorities.
The FTC expressed concern that our report could give the impression that
we are suggesting that Congress consider giving the Board sole
jurisdiction—rather than concurrent jurisdiction with FTC—over nonbank
subsidiaries of holding companies. Our report did not intend to suggest
that the Congress make any change that would necessarily affect FTC’s
existing authority for these entities, and we modified the report to clarify
this point.
Introduction Chapte1
r
The Nature and Predatory lending is an umbrella term that is generally used to describe
cases in which a broker or originating lender takes unfair advantage of a
Attributes of Predatory borrower, often through deception, fraud, or manipulation, to make a loan
Lending that contains terms that are disadvantageous to the borrower. While there
is no universally accepted definition, predatory lending is associated with
the following loan characteristics and lending practices:
• Excessive fees. Abusive loans may include fees that greatly exceed the
amounts justified by the costs of the services provided and the credit
and interest rate risks involved. Lenders may add these fees to the loan
amounts rather than requiring payment up front, so the borrowers may
not know the exact amount of the fees they are paying.
1
Throughout this report, the terms predatory lending and abusive lending are used
interchangeably.
2
As discussed in chapter 4, the secondary market is where existing mortgage loans and
mortgage-backed securities are sold and purchased.
Emergence of The market for mortgage loans has evolved considerably over the past 20
years. Among the changes has been the emergence of a market for
Subprime Mortgage subprime mortgage loans. Most mortgage lending takes place in what is
Market known as the prime market, which encompasses traditional lenders and
borrowers with credit histories that put them at low risk of default. In
contrast, the subprime market serves borrowers who have poor or no
credit histories or limited incomes, and thus cannot meet the credit
standards for obtaining loans in the prime market.3 It is widely accepted
that the overwhelming majority of predatory lending occurs in the
subprime market, which has grown dramatically in recent years. Subprime
mortgage originations grew from $34 billion in 1994 to more than $213
billion in 2002 and in 2002 represented 8.6 percent of all mortgage
originations, according to data reported by the trade publication Inside
B&C Lending. Several factors account for the growth of the subprime
market, including changes in tax law that increased the tax advantages of
home equity loans, rapidly increasing home prices that have provided many
consumers with substantial home equity, entry into the subprime market by
companies that had previously made only prime loans, and the expansion
of credit scoring and automated underwriting, which has made it easier for
lenders to price the risks associated with making loans to credit-impaired
borrowers.
Originating lenders charge higher interest rates and fees for subprime loans
than they do for prime loans to compensate for increased risks and for
higher servicing and origination costs. In many cases, increased risks and
costs justify the additional cost of the loan to the borrower, but in some
cases they may not. Because subprime loans involve a greater variety and
complexity of risks, they are not the uniformly priced commodities that
prime loans generally are. This lack of uniformity makes comparing the
costs of subprime loans difficult, which can increase borrowers’
vulnerability to abuse.
3
There is no uniform definition across the lending industry for what characterizes a loan as
subprime. Subprime loans are generally given to borrowers with credit scores that are
below a certain threshold, but that threshold can vary according to the policies of the
individual lender.
About half of all mortgage loans are made through mortgage brokers that
serve as intermediaries between the borrower and the originating lender.
According to government and industry officials, while the great majority of
mortgage brokers are honest, some play a significant role in perpetrating
predatory lending. A broker can be paid for his services from up-front fees
directly charged to the borrower and/or through fees paid indirectly by the
borrower through the lender in what is referred to as a “yield spread
premium.”5 Some consumer advocates argue that compensating brokers
this way gives brokers an incentive to push loans with higher interest rates
and fees. Brokers respond that yield spread premiums in fact allow them
to reduce the direct up-front fees they charge consumers.
4
HUD annually identifies a list of lenders that specialize in either subprime or manufactured
home lending. HUD occasionally updates data related to past years. The information
provided here was based on data available as of November 7, 2003.
5
A “yield spread premium” is a payment a mortgage broker receives from a lender based on
the difference between the actual interest rate on the loan and the rate the lender would
have accepted on the loan given the risks and costs involved. The higher the actual loan rate
compared with the acceptable loan rate, the higher the yield spread premium.
The Extent of Currently no comprehensive and reliable data are available on the extent of
predatory lending nationwide, for several reasons. First, the lack of a
Predatory Lending Is standard definition of what constitutes predatory lending makes it
Unknown inherently difficult to measure. Second, any comprehensive data collection
on predatory lending would require access to a representative sample of
loans and to information that can only be extracted manually from the
physical loan files. Given that such records are not only widely dispersed
but also generally proprietary, to date comprehensive data have not been
collected.6 Nevertheless, policymakers, advocates, and some lending
industry representatives have expressed concerns in recent years that
predatory lending is a significant problem. Although the extent of
predatory lending cannot be easily quantified, several indicators suggest
that it may be prevalent. Primary among these indicators are legal
settlements, foreclosure patterns, and anecdotal evidence.
6
One of the few studies that sought to quantify the extent of predatory lending was
“Quantifying the Economic Cost of Predatory Lending,” E. Stein, Coalition for Responsible
Lending, July 25, 2001 (revised Oct. 30, 2001). We were not able to verify the reliability of
the study’s data, which were based on several sources. Other empirical data appears in a
study by Freddie Mac on its automated underwriting system, “Automated Underwriting:
Making Mortgage Lending Simpler and Fairer for America’s Families,” September 1996. The
company evaluated a sample of 15,000 subprime mortgage loans originated by four financial
institutions and provided preliminary estimates that between 10 and 35 percent of the
borrowers who received these loans could have qualified for a loan in the prime market.
Some consumer advocates have said these data suggest that some borrowers may be
“steered” to high-cost loans even though they qualify for conventional loans with better
terms. A Freddie Mac official told us that the data are insufficient to necessarily draw that
conclusion.
Further, between January 1998 and September 1999, the foreclosure rate
for subprime loans was more than 10 times the foreclosure rate for prime
loans.8 While it would be expected that loans made to less creditworthy
borrowers would result in some increased rate of foreclosure, the
magnitude of this difference has led many analysts to suggest that it is at
least partly the result of abusive lending, particularly of loans made without
regard to the borrower’s ability to repay. Moreover, the rate of foreclosures
of subprime mortgage loans has increased substantially since 1990, far
exceeding the rate of increase for subprime originations. A study
conducted for HUD noted that while the increased rate in subprime
foreclosures could be the result of abusive lending, it could also be the
result of other factors, such as an increase in subprime loans that are made
to the least creditworthy borrowers.9
7
Citigroup acquired Associates First Capital Corporation and Associates Corporation of
North America in November 2000 and merged The Associates’ consumer finance operations
into its subsidiary, CitiFinancial Credit Company.
8
See HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home Mortgage
Lending: A Joint Report (June 2000), 34-35. The report noted that from January 1998
through September 1999, foreclosure rates averaged 0.2 percent for prime mortgage loans
and 2.6 percent for subprime mortgage loans.
9
Harold L. Bunce, Debbie Gruenstein, Christopher E. Herbert, and Randall M. Scheessele,
“Subprime Foreclosures: The Smoking Gun of Predatory Lending?” Paper presented at the
U.S. Department of Housing and Urban Development conference “Housing Policy in the
New Millennium,” Crystal City, VA, October 2000.
10
Hearing on “Equity Predators: Stripping, Flipping and Packing Their Way to Profits,”
Special Committee on Aging, U.S. Senate, March 16, 1998. Hearing on “Predatory Mortgage
Lending: The Problem, Impact and Responses,” Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, July 26 and 27, 2001. Hearing on “Predatory Mortgage Lending
Practices: Abusive Uses of Yield Spread Premiums,” Committee on Banking, Housing, and
Urban Affairs, U.S. Senate, January 8, 2002. Hearing on “Protecting Homeowners:
Preventing Abusive Lending While Preserving Access to Credit,” Subcommittees on
Financial Institutions and Consumer Credit and Housing and Community Opportunity,
Committee on Financial Services, House of Representatives, November 5, 2003.
11
A Rural Housing Institute report found that predatory lending did not appear to have
infiltrated rural counties in Iowa as much as urban counties. However, the institute also
noted there have been reports of many cases of predatory lending in rural areas of the
country overall, with comparably severe effects on rural victims. See Rural Voices, Vol. 7,
No. 2, Spring 2002, 4-5.
12
See Pub. L. 103-325 §§ 151-158, 108 Stat. 2190-2198.
overall review of the statutory requirements for mortgage loans, HUD and
the Board released a report recommending that additional actions be taken
to protect consumers from abusive lending practices.13 HUD and the
Department of the Treasury formed a task force in 2000 that produced the
report Curbing Predatory Home Mortgage Lending, which made several
dozen recommendations for addressing predatory lending.14, 15
Objectives, Scope, and Our objectives were to describe (1) federal laws related to predatory
lending and federal agencies’ efforts to enforce them; (2) the actions taken
Methodology by the states in addressing predatory lending; (3) the secondary market’s
role in facilitating or inhibiting predatory lending; (4) how consumer
education, mortgage counseling, and loan disclosures may deter predatory
lending; and (5) the relationship between predatory lending activities and
elderly consumers. The scope of this work was limited to home mortgage
lending and did not include other forms of consumer loans.
13
Board of Governors of the Federal Reserve System and Department of Housing and Urban
Development, Joint Report to the Congress Concerning Reform to the Truth in Lending
Act and the Real Estate Settlement Procedures Act, July 1998.
14
HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home Mortgage
Lending: A Joint Report, June 2000.
15
During 2003, there were at least two bills introduced in Congress that addressed predatory
or abusive lending practices—the Responsible Lending Act (H.R. 833, Feb. 13, 2003) and the
Predatory Lending Consumer Protection Act of 2003 (S. 1928, Nov. 21, 2003).
We provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
comment. The agencies provided technical comments that have been
incorporated, as appropriate, as well as general comments that are
discussed at the end of chapter 2. The written comments of the Board,
DOJ, HUD, and NCUA are printed in appendixes II through V. We
conducted our work between January 2003 and January 2004 in accordance
Federal Agencies Use a As shown in figure 1, Congress has passed numerous laws that can be used
to protect consumers against abusive lending practices. Federal agencies
Variety of Laws to have applied provisions of these laws to seek redress for consumers who
Address Predatory have been victims of predatory lending. Among the most frequently used
laws are TILA, HOEPA, the Real Estate Settlement Procedures Act
Lending Practices (RESPA), and the FTC Act. 2 Congress has also given certain federal
agencies responsibility for writing regulations that implement these laws.
For example, the Board writes Regulation Z, which implements TILA and
HOEPA, and HUD writes Regulation X, which implements RESPA. Also, in
some cases, DOJ has brought actions under criminal fraud statutes based
on conduct that can constitute predatory lending.
1
HOEPA amended various provisions of the Truth In Lending Act. In the context of this
report, the term “federal banking regulators” refers to the Board, the federal supervisory
agency for state-chartered banks that are members of the Federal Reserve System; OCC,
which supervises national banks and their subsidiaries; FDIC, the federal regulator
responsible for insured state-chartered banks that are not members of the Federal Reserve
System; OTS, the primary federal supervisory agency for federally insured thrifts and their
subsidiaries; and NCUA, which supervises federally insured credit unions.
2
TILA, as amended, is codified at 15 U.S.C. §§ 1601 – 1667f (2000 & Supp 2003). The
pertinent consumer protection provisions of the FTC Act are contained in 15 U.S.C. §§ 41 –
58 (2000). RESPA is codified at 12 U.S.C. §§ 2601 – 2617 (2000 & Supp 2003).
Figure 1: Federal Laws and Statutes Used to Address Lending Practices Generally Considered to be Predatory
Federal
Predatory Title 18 of banking
lending practice a
TILA HOEPA RESPA FTC Act U.S. Code regulators FTC HUD DOJ
Failure to disclose
actual loan costs
Prohibited fees
and payments
Lending without
regard to ability
to repay
Loan flipping
Prohibited
prepayment penalties
Prohibited
balloon payments
Source: GAO.
a
HOEPA covers only a limited portion of all subprime loans.
TILA, which became law in 1968, was designed to provide consumers with
accurate information about the cost of credit. Among other things, the act
requires lenders to disclose information about the terms of loans—
including the amount being financed, the total finance charge, and
information on the annual percentage rate—that can help borrowers
understand the overall costs of their loans. TILA also provides borrowers
with the right to cancel certain loans secured by a principal residence
within 3 days of closing or 3 days of the time at which the final disclosure is
made, whichever is later.3
3
See 15 U.S.C. § 1635.
4
HOEPA covers closed-end refinancing loans and home equity loans with either (i) an
annual percentage rate that exceeds the rate for Treasury securities with comparable
maturities by more than a specified amount, or (ii) points and fees that exceed the greater of
8 percent of the loan amount or $400, which is adjusted annually for inflation. 15 U.S.C. §
1602(aa)(1), (3); see 12 C.F.R. § 226.32 (2003). HOEPA does not apply to purchase money
mortgages (i.e., loans to purchase or construct a residence), open-end credit (i.e., a line of
credit), and reverse mortgages. See, e.g., 15 U.S.C. § 1639.
5
The Board has cited a study conducted for the American Financial Services Association
that estimated that—using current triggers—HOEPA would have covered nearly 38 percent
of subprime first mortgage loans originated by nine major national lenders from 1995-2000.
See M. Staten and G. Elliehausen, “The Impact of The Federal Reserve Board’s Proposed
Revisions to HOEPA on the Number and Characteristics of HOEPA Loans” (July 24, 2001). In
the past, the Board has also cited estimates from data from OTS that, using the current
triggers, HOEPA would cover roughly 5 percent of all subprime loans, but the Board noted
to us that this estimate may be conservative. See 65 Fed. Reg. at 81441.
6
Negative amortization occurs when loan payment amounts do not cover the interest
accruing on a loan, resulting in an increasing outstanding principal balance over time. See
15 U.S.C. § 1639(f).
7
See Pub. L. No. 103-325 § 153(a), 15 U.S.C. § 1640(a).
8
Among other things, RESPA requires the good faith disclosure of estimated settlement
costs within 3 days after an application for a mortgage loan and, at or before settlement, a
uniform settlement statement (HUD-1) that enumerates the final cost of the loan.
9
Banking regulators are also authorized to enforce standards imposed pursuant to the FTC
Act with respect to unfair or deceptive acts or practices by the institutions they supervise.
See 12 U.S.C. § 57a(f).
The following other federal laws have been used to a lesser extent to
address abusive lending:
• The Fair Housing Act prohibits discrimination based on race, sex, and
other factors in housing-related transactions, and the Equal Credit
Opportunity Act (ECOA) prohibits discrimination against borrowers in
the extension of credit. Federal agencies have used both laws in cases
against lenders that have allegedly targeted certain protected groups
with abusive loans.
• Finally, FTC and the banking regulators can also use the Fair Debt
Collection Practices Act and Fair Credit Reporting Act in enforcement
10
On January 20, 2004, FDIC announced approval of a joint interagency notice of proposed
rulemaking regarding the Community Reinvestment Act. The proposed rule would amend
the act’s regulations to expand and clarify the provision that an institution's Community
Reinvestment Act evaluation is adversely affected when the institution has engaged in
specified discriminatory, illegal, or abusive credit practices in connection with certain loans.
FDIC said that the Board, OCC, and OTS were expected to announce their approval of the
proposed rulemaking shortly.
11
Even in instances where charging high interest rates or fees or steering borrowers to
subprime loans do not violate federal consumer protection statutes, imposing such rates
and fees on a discriminatory basis against groups protected under the Fair Housing Act and
ECOA could constitute violations of those laws.
12
A pattern of making loans without regard to the ability of borrowers to repay can be
considered a violation of the safety and soundness requirements imposed on federally
insured depository institutions and could also reflect poorly on an institution’s compliance
with the Community Reinvestment Act. See OCC Advisory Letter 2003-2 (Guidance for
National Banks to Guard Against Predatory and Abusive Lending Practices), February 21,
2003. For loans that are covered under HOEPA, making a loan without regard to a
borrower’s ability to repay is not prohibited unless it can be demonstrated that an institution
has engaged in a “pattern or practice” of doing so. OCC in its recent rulemaking prohibited
national banks or their operating subsidiaries from making consumer loans based
predominantly on the foreclosure or liquidation value of a borrower’s collateral. See 69 Fed.
Reg. 1904 (Jan. 13, 2004).
Federal Agencies Have FTC, DOJ, and HUD have taken enforcement actions to address violations
related to abusive lending.13 As of December 2003, FTC reported that the
Taken Some agency had taken 19 actions against mortgage lenders and brokers for
Enforcement Actions, predatory practices. DOJ has addressed predatory lending that is alleged
to be discriminatory by enforcing fair lending laws in a limited number of
but Banking Regulators cases. HUD’s efforts have generally focused on reducing losses to the
Have Focused on Federal Housing Administration (FHA) insurance fund, including
Guidance and implementing a number of initiatives to monitor lenders for violations of
FHA guidelines.14 HUD reported having taken a small number of actions to
Regulatory Changes enforce RESPA and the Fair Housing Act in cases involving predatory
lending.
13
Most enforcement actions discussed in this chapter were civil judicial actions brought and
settled by FTC, DOJ, and HUD.
14
HUD’s FHA mortgage insurance program makes loans more readily available for low- and
moderate-income families by providing mortgage insurance to purchase or refinance a
home. Lending institutions such as mortgage companies and banks fund the loans.
FTC Has Played the FTC is responsible for implementing and enforcing certain federal laws
Predominant Federal Role among lending institutions that are not supervised by federal banking
regulators. FTC reported that between 1983 and 2003, it filed 19 complaints
in Enforcement Actions alleging deceptive or other illegal practices by mortgage lenders and
Related to Predatory brokers, 17 of them filed since 1998.15 For a list of these FTC enforcement
Lending actions, see appendix I. As of December 2003, FTC had reached
settlements in all but one of the cases. In most of these settlements,
companies have agreed to provide monetary redress to consumers and to
halt certain practices in the future. In some cases, the settlements also
imposed monetary penalties that the companies have paid to the
government. Among the recent enforcement actions related to predatory
lending that the FTC identified are the following:
• First Alliance. In 2002, FTC, along with several states and private
plaintiffs, settled a complaint against First Alliance Mortgage Company
alleging that it violated federal and state laws by misleading consumers
about loan origination and other fees, interest rate increases, and
monthly payment amounts on adjustable rate mortgage loans. The
company agreed to compensate nearly 18,000 borrowers more than $60
15
FTC has also recently addressed abuses in the mortgage loan servicing industry. In
November 2003, it announced settlements with Fairbanks Capital Holding Corp., its wholly
owned subsidiary Fairbanks Capital Corp., and their founder and former CEO (collectively,
Fairbanks) on charges that Fairbanks violated the FTC Act, RESPA, and other laws by
failing to post consumers’ mortgage payments in a timely manner and charging consumers
illegal late fees and other unauthorized fees. The settlement will provide $40 million in
redress to consumers. The case was jointly filed with HUD. United States of America v.
Fairbanks Capital Corp. et al., Civ. Action No. 03-12219-DPW (D. Mass.)(filed 11/12/03).
16
Citigroup, Inc., acquired The Associates in a merger that was completed in November 2000.
The FTC complaint named Citigroup and CitiFinancial Credit Company as successor
defendants.
• Fleet Finance and Home Equity U.S.A. In 1999, Fleet Finance, Inc., and
Home Equity U.S.A., Inc., settled an FTC complaint alleging violations of
the FTC Act, TILA, and related regulations. These violations included
failing to provide required disclosures about home equity loan costs and
terms and failing to alert borrowers to their right to cancel their credit
transactions. To settle, the company agreed to pay up to $1.3 million in
redress and administrative costs and to refrain from violating TILA in
the future.
FTC staff expressed their belief that the agency’s enforcement actions over
the years have been successful in deterring other lenders from engaging in
abusive practices. However, in a congressional hearing in 2000 FTC had
requested statutory changes that would improve its ability to enforce
HOEPA. For example, FTC recommended that Congress expand HOEPA to
prohibit the financing of lump-sum credit insurance premiums in loans
covered by HOEPA and to give FTC the power to impose civil penalties for
HOEPA violations.17
17
Prepared statement of the Federal Trade Commission before the House Committee on
Banking and Financial Services on “Predatory Lending Practices in the Subprime Industry,”
May 24, 2000. Since then, many mortgage lenders have said they are abandoning lump-sum
credit insurance.
DOJ Has Enforced Fair DOJ’s Housing and Civil Enforcement Section is responsible for enforcing
Lending Laws in Connection certain federal civil rights laws, including the Fair Housing Act and ECOA.
DOJ identified two enforcement actions it has taken related to predatory
with Predatory Lending mortgage lending practices that it alleged were discriminatory. 18
18
In addition to these cases, DOJ filed an amicus curiae brief in a private case, Hargraves v.
Capital City Mortgage Corp., Civ. Action No. 98-1021 (JHG/AK) (D DC), in which the
department contended that certain alleged predatory lending practices violated the Fair
Housing Act and ECOA. The case involved a mortgage lender that allegedly engaged in a
pattern or practice of deceiving African American borrowers about the terms of their loans
and other information, such as the total amount due. In addition, DOJ filed a complaint in
United States v. Action Loan, Civ. Action No. 3:00CV-511-H (W.D. KY), which resulted from
enforcement efforts by the FTC and HUD and involved allegations of predatory mortgage
lending.
19
United States v. Delta Funding Corp., Civ. Action No. CV 00 1872 (E.D. N.Y. 2000).
20
Two monetary relief funds totaling over $12 million were set up under a previous
remediation agreement involving Delta and the New York State Banking Department.
21
United States v. Long Beach Mortgage Company, Case No. 96-6159 (1996). Prior to
December 1990, Long Beach Bank was a savings and loan association, chartered by the state
of California. Between December 1990 and October 1994, Long Beach Mortgage Company
operated under the name of Long Beach Bank as a federally chartered thrift institution. In
1999, Washington Mutual, a federally chartered thrift, acquired Long Beach Mortgage
Company and owns it at the holding company level.
Representatives from both FTC and DOJ have stated that their enforcement
actions can be very resource intensive and can involve years of discovery
and litigation. For example, FTC filed a complaint against Capitol City
Mortgage Corporation in 1998 that is still in litigation more than 5 years
later. FTC staff told us that because cases involving predatory lending can
be so resource intensive, the agencies try to focus their limited resources
on the cases that will have the most impact, such as those that may result in
large settlements to consumers or that will have some deterrent value by
gaining national exposure. Similarly, DOJ officials select certain
discrimination cases, including those mentioned above, in part because of
their broad impact.
HUD’s Enforcement HUD’s enforcement and regulatory activity with regard to abusive
Activities Focus on FHA mortgage lending comes primarily through its management of the FHA
single-family mortgage insurance programs, its rule-making and
Loans enforcement authority under RESPA, and its enforcement of the Fair
Housing Act.
22
DOJ has also taken enforcement actions to address other practices, such as credit repair
schemes, that do not involve abusive lending but that nonetheless serve to illegally strip
homeowners of their equity.
23
GAO has issued a number of reports on the FHA single-family insurance program, a high-
risk program area. For example, see U.S. General Accounting Office, Major Management
Challenges and Program Risks: Department of Housing and Urban Development,
GAO-03-103 (Washington, D.C.: January 2003).
HUD officials say that programs they have in place to improve the
monitoring of FHA lenders also serve to deter predatory lending. For
example, HUD’s Credit Watch Program routinely identifies those lenders
with the highest early default and insurance claim rates and temporarily
suspends the FHA loan origination approval agreements of the riskiest
lenders, helping to ensure that lenders are not making loans that borrowers
cannot repay. Also, the Neighborhood Watch program provides
information to FHA participants about lenders and appraisers whose loans
have high default and FHA insurance claim rates. HUD told us that it has
also taken a series of actions to better ensure the integrity of appraisals
used to finance FHA insured loans. As of December 2003, HUD was in the
final stages of issuing a rule that would hold lenders accountable for
appraisals associated with loans they make.
24
In property flipping schemes, properties are purchased and quickly resold at grossly
inflated values. In some cases the inflated value is established by an interim sale to a “straw
buyer” and then flipped to an unsuspecting purchaser. In other cases, first-time buyers who
have been turned down for home loans because of poor credit or low income are targeted by
flippers who arrange loans well in excess of the real value of the property using fabricated
employment and deposit records. These schemes often involve many players, including
mortgage lenders, mortgage brokers, underwriters, and home-improvement workers.
Almost all flipping schemes involve false appraisals. While HUD categorizes property
flipping as a predatory lending practice, not all federal agencies concur with this
categorization.
Federal Banking Regulators According to federal banking regulators and state enforcement authorities,
Have Issued Guidance and federally regulated depository institutions—banks, thrifts, and credit
unions—have not typically engaged in predatory lending practices. Federal
Made Regulatory Changes
banking regulators have systems in place to track customer complaints and
reported that they have received few complaints related to predatory
lending by the institutions they supervise. The regulators conduct routine
examinations of these institutions and have the authority, in cases of
suspected predatory lending, to enforce a variety of fair lending and
consumer protection laws. Banking regulators noted that the examination
process, which involves routine on-site reviews of lenders’ activities, serves
as a powerful deterrent to predatory lending by the institutions they
examine.
25
For example, a complaint filed jointly by HUD, FTC, and Illinois authorities against
Mercantile Mortgage Company in 2002 alleged that for almost 3 years, a broker referred
virtually every one of his loan customers to Mercantile in exchange for a fee as high as 10
percent. The other two cases involving RESPA include Delta Funding (2000) and Action
Loan Company (2000).
26
United States of America v. Fairbanks Capital Corp., 03-12219-DPW (D. MA, filed Nov. 12,
2003).
Officials of OTS, FDIC, the Board, and NCUA said that they had taken no
formal enforcement actions related to predatory mortgage lending against
the institutions they regulate. 27 Officials at OCC said they have taken one
formal enforcement action related to predatory mortgage lending to
address fee packing, equity stripping, and making loans without regard to a
borrower’s ability to pay. In November 2003, the agency announced an
enforcement action against Loan Star Capital Bank seeking to reimburse 30
or more borrowers for more than $100,000 in abusive fees and closing costs
that violated the FTC Act, HOEPA, TILA, and RESPA.28 The bank also was
required to conduct a comprehensive review of its entire mortgage
portfolio and to provide restitution to any additional borrowers who may
have been harmed.
While most federal banking regulators stated that they have taken no
formal enforcement actions, representatives from some said they had
taken informal enforcement actions to address some questionable
practices among their institutions. For example, OTS has examined
institutions that may have charged inappropriate fees or violated HOEPA
and resolved the problems by requiring corrective action as part of the
examination process. In addition, most of the banking regulators have
taken formal enforcement actions, including issuing cease-and-desist
orders, in response to activities that violated fair lending and consumer
protection laws but were not necessarily deemed to constitute “predatory
lending.”
Guidance Federal banking regulators have issued guidance to their institutions about
both predatory lending and subprime lending in general. In February 2003,
OCC issued two advisory letters related to predatory lending to the national
banks and the operating subsidiaries it supervises. One letter provided
specific guidelines for guarding against predatory lending practices during
loan originations, and the other alerted institutions to the risk of indirectly
27
Banking regulators have broad enforcement powers and can take formal actions (cease
and desist orders, civil money penalties, removal orders, and suspension orders, among
others) or informal enforcement actions (such as memoranda of understanding and board
resolutions). Not all informal actions are publicly disclosed.
28
Matter of Clear Lake National Bank, AA-EC03-25 (OCC Nov. 7, 2003). The lender that
made the loans, Clear Lake National Bank of San Antonio, Texas, merged with another bank
in April 2003 to become Lone Star Capital Bank, N.A. OCC brought the action under the
enforcement authority provided by Section 8 of the Federal Deposit Insurance Act, 12 U.S.C.
1818.
In 1999 and 2001, the Board, FDIC, OCC, and OTS issued joint guidance to
their institutions on subprime lending in general.31 The guidance
highlighted the additional risks inherent in subprime lending and noted that
institutions engaging in such lending need to be aware of the potential for
predatory practices and be particularly careful to avoid violating fair
lending and consumer protection laws and regulations. The NCUA issued
similar guidance to insured credit unions in 1999.32 Federal banking
29
OCC Advisory Letter 2003-2 (Guidance for National Banks to Guard Against Predatory and
Abusive Lending Practices), February 21, 2003; and OCC Advisory Letter 2003-3 (Avoiding
Predatory and Abusive Lending Practices in Brokered and Purchased Loans), February 21,
2003.
30
69 Fed. Reg. 1904 (Jan. 13, 2004).
31
The Board, FDIC, OCC and OTS, Interagency Guidance on Subprime Lending, March 1,
1999; and Expanded Guidance for Subprime Lending Programs, January 31, 2001. The 2001
guidance applies to institutions with subprime lending programs with an aggregate credit
exposure greater than or equal to 25 percent of Tier 1 capital.
32
NCUA Letter to Credit Unions No. 99-CU-05, Risk Based Lending, June 1999.
Regulatory Changes The Board is responsible for issuing regulations that implement HOEPA
and HMDA, two laws that play a role in addressing predatory lending. In
December 2001, in response to concerns that HOEPA may not be
adequately protecting consumers from abusive lending practices, the
Board amended Regulation Z, which implements HOEPA, to
• lower the interest rate “trigger” that determines whether loans are
covered under HOEPA in order to bring more loans under the protection
of the law,34
• require that fees paid for credit insurance and similar debt protection
products be included when determining whether loans are subject to
HOEPA,
• prohibit creditors that make HOEPA loans from refinancing the loan
within one year of origination with another HOEPA loan, unless the
refinancing is in the borrower’s interest, and
33
See OCC Advisory Letter 2000-7 (abusive lending practices); OCC Advisory Letter 2000-10,
OCC Advisory Letter 2000-11, OTS Chief Executive Officers Letter 131, OTS Chief Executive
Officers Letter 132, and NCUA Letter 01-FCU-03 (title loans and payday lending); OCC
Bulletin 2001-47 (third-party relationships); and OCC Advisory Letter 2002-3 and FDIC
Financial Institution Letter 57-2002 (unfair or deceptive acts or practices).
34
The Board adjusted the annual percentage rate (APR) trigger from 10 to 8 percentage
points above the rate for Treasury securities with comparable maturities. The change
applies only to first lien mortgages; the subordinate lien mortgage APR trigger remained at
10 percent.
35
66 Fed. Reg. 65604 (Dec. 20, 2001).
Because HOEPA expressly grants the Board broad authority to issue rules
to regulate unfair or deceptive acts and practices, some consumer
advocacy organizations have argued that the Board should use its authority
to do more to curb predatory lending.38 For example, some consumer
groups have called on the Board to use its rule-making authority to prohibit
the financing of single-premium credit insurance—a product that is
believed by many to be inherently predatory.39 Under the McCarran
Ferguson Act,40 unless a federal statute is specifically related to the
business of insurance, the federal law may not be construed to invalidate,
impair, or supercede any state law enacted to regulate the business of
insurance. Board officials say it is not clear the extent to which rules
issued by the Board under HOEPA seeking to regulate the sale of single-
premium credit insurance would be consistent with that standard. The
Board has previously recommended that it would be more appropriate for
Congress to address this issue through changes in law. Some consumer
groups also have argued that the Board should increase the loan data
reporting requirements of HMDA to help detect abusive lending. The
36
More specifically, lenders are required to report the difference or spread between a loan’s
annual percentage rate (a value reflecting both the interest rate and certain fees associated
with a loan) and the yield on a Treasury security of comparable maturity, for loans where
this spread exceeds certain thresholds set by the Board. See, generally, 67 Fed. Reg. 7222
(Feb. 15, 2002) and 67 Fed. Reg. 43218 (June 27, 2002).
37
Id.
38
See 15 U.S.C. § 1639(l)(2).
39
In its 2001 amendments to the HOEPA rules, the Board added single-premium credit
insurance to HOEPA’s fee trigger.
40
See 15 U.S.C. § 1012.
Board has added certain loan pricing and other items to the HMDA
reporting requirements, effective in January 2004, but did not add other
data reporting requirements, such as the credit score of the applicant.
Board officials said this is based on the belief that the need for additional
loan data to ensure fair lending must be weighed against the costs and
burdens to the lender of gathering and reporting the additional information.
Agencies Have Coordinated Federal agencies have worked together to investigate and pursue some
on Enforcement Actions cases involving predatory lending. For example, FTC, DOJ, and HUD
coordinated to take enforcement action against Delta Funding
and Participated in
Corporation, with each agency investigating and bringing actions for
Interagency Groups violations of the laws under its jurisdiction. DOJ conducted its
enforcement action against Long Beach Mortgage Company in
coordination with OTS, which investigated the initial complaint in 1993
when the company was a thrift. Federal agencies have also coordinated
with state authorities and private entities in enforcement actions. For
example, in 2002, FTC joined six states, AARP, and private attorneys to
settle a complaint against First Alliance Mortgage Company alleging that
the company used deception and manipulation in its lending practices.
• In the fall of 1999 the Interagency Fair Lending Task Force, which
coordinates federal efforts to address discriminatory lending,
established a working group to examine the laws related to predatory
lending and determine how enforcement and consumer education could
be strengthened.41 Because of differing views on how to define and
combat predatory lending, the group was unable to agree on a federal
interagency policy statement related to predatory lending in 2001. The
Task Force then continued its efforts related to consumer education and
published a brochure in 2003 to educate consumers about predatory
lending practices.
41
The agencies that participated in the working group were OCC, OTS, FDIC, the Board,
NCUA, DOJ, FTC, HUD, the Federal Housing Finance Board, and the Office of Federal
Housing Enterprise Oversight.
• In 2000, HUD and the Department of the Treasury created the National
Task Force on Predatory Lending, which convened forums around the
country to examine the issue and released a report later in the year.43
The report made specific recommendations to Congress, federal
agencies, and other stakeholders that were aimed at (1) improving
consumer literacy and disclosure, (2) reducing harmful sales practices,
(3) reducing abusive or deceptive loan terms and conditions, and
(4) changing structural aspects of the lending market.
42
The Federal Financial Institutions Examination Council is a formal interagency body
composed of representatives of each of the five federal banking regulators. The council was
established in 1979 and is empowered to (1) prescribe uniform principles, standards, and
report forms for the federal examination of financial institutions and (2) make
recommendations to promote uniformity in the supervision of financial institutions.
43
U.S. Department of the Treasury and U.S. Department of Housing and Urban Development,
Curbing Predatory Home Mortgage Lending: A Joint Report, June 2000.
Jurisdictional Issues Jurisdictional issues related to the regulation of certain nonbank mortgage
lenders may challenge efforts to combat predatory lending. Many federally
Related to Nonbank and state-chartered banks and thrifts, as well as their subsidiaries, are part
Subsidiaries Challenge of larger financial holding companies or bank holding companies.44 These
holding companies may also include nonbank financial companies, such as
Efforts to Combat finance and mortgage companies, that are subsidiaries of the holding
Predatory Lending companies themselves. These holding company subsidiaries are frequently
referred to as affiliates of the banks and thrifts because of their common
ownership by the holding company. As shown in figure 2, the federal
regulators of federally and state-chartered banks and thrifts also regulate
the subsidiaries of those institutions. For example, as the primary
regulator for national banks, OCC also examines operating subsidiaries of
those banks. On the other hand, federal regulators generally do not
perform routine examinations of independent mortgage lenders and
affiliated nonbank subsidiaries of financial and bank holding companies
engaged in mortgage lending.
44
A subsidiary of a bank, thrift, or credit union is controlled through partial or complete
ownership by the institution. Federal laws and regulations set more specific requirements
that dictate whether an institution is a subsidiary. For the purposes of this report, the term
holding company refers to both (traditional) bank holding companies and bank holding
companies that qualify as financial holding companies as defined by the Board.
Holding company
(the Board)
Source: GAO.
Note: The primary federal agency for enforcement of the various federal laws used to combat abusive
or predatory lending activities is shown in parentheses.
a
FTC is responsible for enforcing federal laws for lenders that are not depository institutions but it is not
a supervisory agency and does not conduct routine examinations.
45
OCC Advisory Letter 2002-9 (Questions Concerning Applicability and Enforcement of State
Laws: Contacts From State Officials, November 25, 2002.); see also 69 Fed. Reg. 1904
(Jan. 13, 2004).
has stated that the subsidiaries of the institutions it regulates do not play a
large role in subprime lending and that little evidence exists to show that
these subsidiaries are involved in predatory lending. But some state
enforcement authorities and consumer advocates argue otherwise, citing
some allegations of abuses at national bank subsidiaries. However, several
state attorneys general have written that predatory lending abuses are
“largely confined” to the subprime lending market and to non-depository
institutions, not banks or direct bank subsidiaries.46 OCC officials stated
that the agency has strong monitoring and enforcement systems in place
and can and will respond vigorously to any abuses among institutions it
supervises.47 For example, OCC officials pointed to an enforcement action
taken in November 2003 that required restitution of more than $100,000 to
be paid to 30 or more borrowers for fees and interest charged in a series of
abusive loans involving small “tax-lien loans.”
46
See Brief of Amicus Curiae State Attorneys General, National Home Equity Mortgage
Ass’n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.) (March 21, 2003) at 10-11.
47
Another jurisdictional issue is uncertainty as to whether the FTC shares jurisdiction with
federal banking regulators over bank subsidiaries that are not themselves banks (operating
subsidiaries). While OCC maintains it has exclusive regulatory jurisdiction over the
operating subsidiaries of national banks, FTC argues that a provision of the Gramm-Leach-
Bliley Act provides for the two agencies to share jurisdiction. See Pub. L. No. 106-102 §
133(a). A federal district court has upheld FTC’s interpretation. (See Minnesota v. Fleet
Mortg. Corp., 181 F. Supp. 2d 995 (D MN 2001)). We are not aware of any instance in which
this matter has interfered with an FTC enforcement action.
48
In addition to financial and bank holding companies, there are thrift holding companies,
which can include thrifts and other financial institutions. Each thrift holding company is
regulated and subject to examination by OTS. See 12 USC §1467a (b)(4).
with federal consumer protection and fair lending laws in the same way
that the federal regulators monitor their depository institutions.
One reason for the concern about these entities is that nonbank
subsidiaries of holding companies conduct a significant amount of
subprime mortgage lending. Of the total subprime loan originations made
by the top 25 subprime lenders in the first 6 months of 2003, 24 percent
were originated by nonbank subsidiaries of holding companies. In
addition, of the 178 lenders on HUD’s 2001 subprime lender list, 20 percent
were nonbank subsidiaries of holding companies. These types of
subsidiaries have also been targets of some of the most notable federal and
state enforcement actions involving abusive lending. For example, The
Associates and Fleet Finance, which were both nonbank subsidiaries of
bank holding companies, were defendants in two of the three largest cases
involving subprime lending that FTC has brought.49
49
Citigroup acquired The Associates in November 2000 and merged The Associates’
consumer finance operations into its subsidiary, CitiFinancial Credit Company, a nonbank
subsidiary of the holding company. In 1999, Fleet Finance, Inc., and its successor company,
Home Equity U.S.A., Inc., agreed to pay $1.3 million to settle an FTC complaint alleging
deceptive disclosures and TILA violations in conjunction with Fleet Finance, Inc., loans. At
the time of the settlement, Fleet Finance had become Home Equity U.S.A., Inc. Both Fleet
Finance, Inc., and Home Equity U.S.A., Inc., were nonbank subsidiaries of bank holding
companies. At the time of the settlement, the bank holding company was Fleet Financial
Group, Inc., which has been renamed FleetBoston Financial Corporation. Home Equity
U.S.A., Inc., continues to operate as a nonbank subsidiary of FleetBoston Financial
Corporation, a bank holding company.
For this reason, FTC is the primary federal agency monitoring nonbank
subsidiaries’ compliance with consumer protection laws. FTC is the
primary federal enforcer of consumer protection laws for these nonbank
subsidiaries, but it is a law enforcement rather than supervisory agency.
Thus, FTC’s mission and resource allocations are focused on conducting
investigations in response to consumer complaints and other information
rather than on routine monitoring and examination responsibilities.
Moreover, as discussed elsewhere in this report, states vary widely in the
extent to which they regulate practices that can constitute predatory
lending.
50
See U.S. General Accounting Office, Large Bank Mergers: Fair Lending Review Could be
Enhanced With Better Coordination, GAO/GGD-00-16 (Washington, D.C.: Nov. 3, 1999), 20
and 47.
Conclusions Under a number of laws, federal agencies have taken action to protect
consumers from abusive lending practices. While FTC has taken a number
of significant enforcement actions to battle abuses in the industry, its
resources are finite and, as a law enforcement agency, it does not routinely
monitor or examine lenders, including the mortgage lending subsidiaries of
financial and bank holding companies.
then refer its findings to DOJ, HUD, or FTC or take its own enforcement
action if a problem exists. Granting the Board concurrent enforcement
authority—with the FTC—for these nonbank subsidiaries of holding
companies would not diminish FTC’s authority under federal laws used to
combat predatory lending.
Matters for To enable greater oversight of and potentially deter predatory lending from
occurring at certain nonbank lenders, Congress should consider making
Congressional appropriate statutory changes to grant the Board of Governors of the
Consideration Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of financial
and bank holding companies for compliance with federal consumer
protection laws applicable to predatory lending practices. Also, Congress
should consider giving the Board specific authority to initiate enforcement
actions under those laws against these nonbank mortgage lending
subsidiaries.
Agency Comments and GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
Our Evaluation comment. The agencies provided technical comments that have been
incorporated, as appropriate. In addition, the Board, DOJ, FDIC, FTC,
HUD, and NCUA provided general comments, which are discussed below.
The written comments of the Board, DOJ, HUD, and NCUA are printed in
appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as different
supervisory schemes being applied to nonbank mortgage lenders based on
The FTC expressed concern that our report could give the impression that
we are suggesting that Congress consider giving the Board sole
jurisdiction—rather than concurrent jurisdiction with FTC—over nonbank
subsidiaries of holding companies. Our report did not intend to suggest
that the Congress make any change that would necessarily affect FTC’s
existing authority for these entities and we modified our report to clarify
this point. To illustrate the difference in regulatory and enforcement
approaches, our draft report contrasted the Board’s routine examination
authority with the FTC’s role as a law enforcement agency. In its
comments, FTC noted that it uses a number of tools to monitor nonbank
mortgage lenders, of which consumer complaints is only one. The agency
also commented that a key difference between the FTC and the Board is
that the Board has access to routine information to aid in its oversight as
part of the supervisory process. Our report did not intend to suggest that
the FTC’s actions are based solely on consumer complaints, and we revised
the report to avoid this impression.
In part because of concerns about the growth of predatory lending and the
limitations of existing state and federal laws, 25 states, the District of
Columbia, and 11 localities had passed their own laws addressing
predatory lending practices as of January 9, 2004.1 Most of the state laws
restrict the terms or provisions of certain high-cost loans, while others
apply to a broader range of loans. In addition, some states have taken
measures to strengthen the regulation and licensing of mortgage lenders
and brokers, and some have used existing state consumer protection and
banking laws to take enforcement actions related to abusive lending.
However, regulators of federally chartered financial institutions have
issued opinions stating that federal laws may preempt some state predatory
lending laws and that nationally chartered lending institutions should have
to comply only with a single uniform set of national standards. Many state
officials and consumer advocates have opposed federal preemption of state
predatory lending laws on the grounds that it interferes with the states’
ability to protect consumers.
States and Localities Since 1999, many states and localities have passed laws designed to
address abusive mortgage lending by restricting the terms or provisions of
Have Addressed certain loans. In addition, states have increased the registration or
Predatory Lending licensing requirements of mortgage brokers and mortgage lenders and have
undertaken enforcement activities under existing consumer protection
through Legislation, laws and regulations to combat abusive lending.
Regulation, and
Enforcement Actions
1
Except where citations to provisions of state laws are provided, all information relating to
state and local laws and their provisions is from a database maintained by Butera &
Andrews, a Washington, D.C., law firm that tracks predatory lending legislation. These laws
include only state and local laws that place actual restrictions on lending and do not include,
for example, local ordinances that consist solely of a resolution that condemned predatory
lending. As noted in chapter 1, we took measures to verify the reliability of these data.
A Growing Number of According to the database of state laws, as of January 9, 2004, 25 states and
States and Localities Have the District of Columbia had passed laws that were specifically designed to
address abusive lending practices.2 (See fig. 3.) These laws were motivated,
Passed Laws to Address at least in part, by growing evidence of abusive lending and by concerns
Abusive Lending that existing laws were not sufficient to protect consumers against abusive
lending practices.
Figure 3: States and Localities That Have Enacted Predatory Lending Laws
2
North Carolina enacted the first state law (N.C. Gen. Stat. 24-1-.1E[1999]) in 1999; it took
effect on July 1, 2000. Nearly all the other state laws were enacted between 2001 and 2003.
Based on our review of the database of state laws, the predatory lending
statutes in 20 of the 25 states regulate and restrict the terms and
characteristics of certain kinds of “high-cost” or “covered” mortgage loans
that exceed certain interest rate or fee triggers.3 Some state laws, such as
those in Florida, Ohio, and Pennsylvania, use triggers that are identical to
those in the federal HOEPA statute but add provisions or requirements,
such as restrictions on refinancing a loan under certain conditions.4 Other
state laws, such as those of Georgia, New Jersey and North Carolina, use
triggers that are lower than those in HOEPA and therefore cover more
loans than the federal legislation.5 Some states design their triggers to vary
depending on the amount of the loan. For example, in New Mexico and
North Carolina, covered loans greater than $20,000 are considered high
cost if the points and fees on the loan exceed 5 percent of the total loan
amount (North Carolina) or equal or exceed it (New Mexico). In these
states, loans for less than $20,000 are considered high cost if the points and
fees exceed either 8 percent of the total or $1,000.6 In the remaining 5
states, the predatory lending laws apply to most mortgage loans; there is no
designation of loans as high cost. For example, West Virginia’s law in effect
generally prohibits lenders from charging prepayment penalties on any
loans and restricts points and fees to either 5 or 6 percent, depending on
whether the loan includes a yield spread premium.7 Michigan’s law
prohibits the financing of single-premium credit insurance into loans.8
3
Massachusetts has imposed similar restrictions on high-cost loans, but it was done through
regulatory changes rather than legislation.
4
See, e.g., Fla. Stat. Ann. §§ 494.0079, 494.00791 (2003); Ohio Rev. Code Ann. §§ 1394; Ohio
Rev. Code Ann. § 1349.25 (2003); 63 PA Stat. § 456.503 (2003).
5
See GA Code Ann. § 7-6A-2(2003); N.J. Stat. Ann. § 46:10B-24 (West 2003); N.C. Gen. Stat. §
24-1.1E (2003).
6
N.C. Gen. Stat. § 24-1-1E; N.M. Stat. Ann § 58-21A-3 (2003).
7
W. VA. Code §§ 46A-3-110, 31-17-8 (2003).
8
See Mich. Comp. Laws § 445.1634 (2003).
9
In some cases, these laws were enacted but pending litigation stayed enforcement.
Some States Have Increased In general, states have regulated mortgage lenders and brokers, although to
the Regulation of Lenders varying degrees. Some state officials told us that because of concerns that
unscrupulous mortgage lenders and brokers were not adequately regulated
and Brokers and and were responsible for lending abuses, some states have increased their
Undertaken Enforcement regulation or licensing requirements of lenders and brokers. As part of
Activities to Combat their licensing requirements, states sometimes require that these
Predatory Lending companies establish a bond to help compensate victims of predatory
lenders or brokers that go out of business, and some states also require that
individuals working for or as mortgage lenders and brokers meet certain
educational requirements.
State law enforcement agencies and banking regulators have also taken a
number of actions in recent years to enforce existing state consumer
protection and banking laws in cases involving predatory lending. For
example, an official from the Washington Department of Financial
Institutions reported that it has taken several enforcement actions in recent
years to address predatory lending. In one such action, a California
mortgage company that allegedly deceived borrowers and made prohibited
charges was ordered to return more than $700,000 to 120 Washington State
borrowers. According to officials of the Conference of State Bank
Supervisors, states reported that in addressing predatory lending they have
usually relied on general state consumer protection laws in areas such as
fair lending, licensing, and unfair and deceptive practices. In some states,
consumer protection statutes do not apply to financial institutions, so state
banking regulators, rather than the attorneys general, typically initiate
enforcement activities. Because allegations of predatory practices often
involve lending activities in multiple states, states have sometimes
cooperated in investigating alleged abuses and negotiating settlements.
For example, in 2002 a settlement of up to $484 million with Household
Finance Corporation resulted from a joint investigation begun by the
attorneys general and financial regulatory agencies of 19 states and the
Activities in North States have varied in their approaches to addressing predatory lending
issues. We reviewed legislative and enforcement activities related to
Carolina and Ohio predatory lending in two states, North Carolina and Ohio, to illustrate two
Illustrate State different approaches.
Approaches to
Predatory Lending
Impact of North Carolina’s North Carolina has enacted two separate laws to address concerns about
Laws on High-Cost Loans predatory lending. In 1999, the legislature passed a law that attempted to
curb predatory lending by prohibiting specific lending practices and
and Licensing of Brokers
restricting the terms of high-cost loans.10 In 2001, North Carolina
and Originators Remains supplemented its predatory lending law by adopting legislation that
Uncertain required the licensing of mortgage professionals (mortgage lenders,
brokers, and loan officers), defined a number of prohibited activities
related to the making of residential mortgages, and enhanced the
enforcement powers of the banking commissioner.11
10
N.C. Session Law 1999-332.
11
N.C. Sessions Laws 2001-393 and 2001-399.
Although the North Carolina predatory lending law governs the practices of
lenders and mortgage brokers, some groups questioned whether it
provided for effective enforcement. Specifically, concerns were focused on
the lack of state licensing and oversight of all segments of the mortgage
lending profession, including mortgage brokers and bankers. Additionally,
some critics asserted that the statute provided the state banking
commissioner with limited and uncertain authority to enforce the
predatory lending provisions. As a result, even before the predatory
lending legislation passed, stakeholders worked on a measure to fill the
gaps left by the state’s predatory lending law.
12
The North Carolina predatory lending law defines a high-cost loan as a home loan of
$300,000 or less that has one or more of the following characteristics: (1) points, fees
(excluding certain amounts specified in the law), and other charges totaling more than 5
percent of the borrowed amount if the loan is $20,000 or more, or the lesser of 8 percent of
the amount borrowed or $1,000 if the loan is less than $20,000; (2) an interest rate that
exceeds by more than 10 percent per annum the yield on comparable Treasury bills; or (3) a
prepayment penalty that could be collected more than 30 months after closing or that is
greater than 2 percent of the amount prepaid. According to the North Carolina
Commissioner of Banks, the $300,000 cap is based on the presumption that those able to
borrow $300,000 or more are able to adequately protect themselves. “Consumer home
loans” are loans in which (i) the borrower is a natural person, (ii) the debt is incurred by the
borrower primarily for personal, family, or household purposes, and (iii) the loan is secured
by a mortgage or deed of trust upon real estate upon which there is located or there is to be
located a structure or structures designed principally for occupancy of from one to four
families which is or will be occupied by the borrower as the borrower’s principal dwelling.
North Carolina’s second statute, the Mortgage Lending Act, was signed into
law on August 29, 2001. Prior to the act, some mortgage banking firms and
all mortgage brokerages domiciled in the state had been required to
register with the state’s banking regulator, but individual loan originators
were not. The Mortgage Lending Act imposed licensing requirements on all
mortgage bankers and brokers, including individuals who originate loans,
and added continuing education and testing requirements for mortgage
loan officers. The provisions of the act mean that individuals as well as
firms are now subject to regulatory discipline. According to the North
Carolina Commissioner of Banks, the act has been effective in reducing the
number of abusive brokers and individual loan originators. The
commissioner noted that a large number of applications for licenses have
been denied because the applicants did not meet basic requirements or did
not pass the required background check.
Our review of the five studies available on the impact of the North Carolina
predatory lending law suggested that data limitations and the lack of an
accepted definition of predatory lending make determining the law’s
impact difficult. For example, information about borrowers’ risk profiles,
the pricing and production costs of the loans, and the lenders’ and
borrowers’ behaviors was not available to the study researchers. In
addition, the extent to which any potential reductions in predatory loans
13
Elliehausen and Staten, Regulation of Subprime Mortgage Products: An Analysis of
North Carolina’s Predatory Lending Law, Georgetown University School of Business
(November 2002).
14
Quercia, Stegman, and Davis, The Impact of North Carolina’s Anti-Predatory Lending
Law: A Descriptive Assessment, Center for Community Capitalism, The Frank Hawkins
Kenan Institute of Private Enterprise, University of North Carolina at Chapel Hill (June 25,
2003).
Ohio Has Preempted Local In February 2002, the Ohio legislature enacted a law with the purpose of
Laws and Taken Action to bringing Ohio law into conformance with HOEPA.15 Among other things,
the legislation preempted certain local predatory lending ordinances. The
Regulate Mortgage Brokers
law was passed in response to an ordinance enacted in the city of Dayton,
which was designed to fight predatory lending by regulating mortgage
loans originated in that city. Proponents of the state law argued that
regulating lenders is a state rather than municipal function and that lending
rules should be uniform throughout the state. Some advocates argued that
the state law prevents cities from protecting their citizens from abusive
lending practices.
15
See Ohio Rev. Code. Ann. § 1349.32 (2003).
16
Ohio Rev. Code Ann. § 1349.27 (2002).
17
See Ohio. Rev. Code Ann. §§ 1322.01 – 1322.12 (2003).
mortgage brokers and loan officers receive continuing education and take
prelicensing competency tests.
In the act adopting HOEPA standards, the Ohio legislature also established
a Predatory Lending Study Committee, which was charged with
investigating the impact of predatory lending practices on the citizens and
communities of Ohio.18 The study committee consisted of 15 members,
including representatives from state agencies, consumer groups, and the
lending industry. The act required the committee to submit a report to the
governor and legislators by the end of June 2003. The committee reached
consensus on two major issues. First, it recommended that all appraisers
in the state be licensed and subject to criminal background checks, and
second, it recommended increased enforcement of the Ohio Mortgage
Broker Act. The Division of Financial Institutions, which is responsible for
enforcing the Ohio Mortgage Broker Act, has hired additional staff to
ensure compliance with the law. The report and recommendations have
been forwarded to the governor and the committee suggested that the Ohio
General Assembly consider all recommendations.
18
2002 Ohio Laws HB 386 § 5.
19
Ordinance No. 271-03. As of November 17, 2003, the City of Toledo was temporarily
enjoined from enforcing application, enforcement, or other effectuation of this ordinance as
a result of a lawsuit asserting that the ordinance is preempted by the Home Ownership and
Equity Protection Act of Ohio. AFSA v. City of Toledo, Ohio, No. C10200301547 (Lucas
County).
Regulators Have Significant debate has taken place as to the advantages and disadvantages
of state and local predatory lending laws. In several cases, regulators of
Determined That federally supervised financial institutions have determined that federal
Federal Law Preempts laws preempt state predatory lending laws for the institutions they
regulate. In making these determinations, two regulators—OCC and
Some State Predatory OTS—have cited federal law that provides for uniform regulation of
Lending Laws, but federally chartered institutions and have noted the potential harm that
Views on Preemption state predatory lending laws can have on legitimate lending.
Representatives of the lending industry and some researchers agree with
Differ the federal banking regulators, arguing that restrictive state predatory
lending laws may ultimately hurt many borrowers by reducing the supply of
lenders willing to make subprime loans, creating undue legal risks for
legitimate lenders, and increasing the costs of underwriting mortgage
loans. Moreover, industry representatives have said that most predatory
lending practices are already illegal under federal and state civil and
criminal laws and that these laws should simply be more stringently
enforced. In contrast, many state officials and consumer advocates are
opposed to federal preemption of state predatory lending laws. They
maintain that federal laws related to predatory lending are insufficient, and
thus preemption interferes with their ability to protect consumers in their
states, particularly from any potential abuses by the subsidiaries of
federally chartered institutions.
OCC, OTS, and NCUA Have Because both the federal and state governments have roles in chartering
Determined That Federal and regulating financial institutions, questions can arise as to whether a
federal statute preempts particular state laws.20 Affected parties may seek
Law Preempts Some State
guidance from federal agencies requesting their views on whether a
Predatory Lending Laws particular federal statute preempts a particular state law; in these
instances, the agency may issue an advisory opinion or order on the issue.
Because the courts are ultimately responsible for resolving conflicts
between federal and state laws, these advisory opinions and orders are
subject to court challenge and review. As of November 2003, one or more
federal regulators had determined that federal laws preempted the
predatory mortgage lending laws of the District of Columbia and five
20
See U.S. General Accounting Office, Role of the Office of Thrift Supervision and Office of
the Comptroller of the Currency in the Preemption of State Law, GAO/GGD/OGC-00-51R
(Washington, D.C.: Feb. 7, 2000) for additional information on federal preemption of state
banking laws.
states—Georgia, New Jersey, New Mexico, New York, and North Carolina.
(See table 1.)
Source: GAO.
21
2 C.F.R § 560.2(a).
22
69 Fed. Reg. 1904 (Jan. 13, 2004).
list examples of the types of state statutes that are preempted (such as laws
regulating credit terms, interest rates, and disclosure requirements) and
examples of the types of state laws that would not be preempted (such as
laws pertaining to zoning, debt collection, and taxation). When OCC first
proposed these rules, one news article stated that it “triggered a flood of
letters and strong reactions from all corners of the predatory lending
debate.” States and consumer groups were critical of the proposal. In
contrast, the Mortgage Bankers Association of America and some large
national banking companies wrote comment letters in support of OCC’s
proposed rules.
Views Differ on the Federal banking regulators point out that preemption of states’
Implications of Federal antipredatory lending laws applies only to institutions chartered by the
agency issuing the preemption order. For example, OTS’s preemption
Preemption of State
opinion served to preempt New Jersey’s predatory lending statute for
Predatory Lending Laws federally chartered thrifts but did not affect the statute’s applicability to
independent mortgage companies, national banks, and state-chartered
banks and thrifts. In preempting the New Jersey Home Ownership Security
Act of 2002, OTS’s Chief Counsel noted that requiring federally chartered
thrifts to comply with a hodgepodge of conflicting and overlapping state
lending requirements would undermine Congress’s intent that federal
savings institutions operate under a single set of uniform laws and
regulations that would facilitate efficiency and effectiveness.23 Federal
banking regulators have said that they have found little to no evidence of
predatory lending by the institutions they regulate, pointing out that
federally supervised institutions are highly regulated and subject to
comprehensive supervision.24 They have also noted that they have issued
guidance and taken numerous other steps to ensure that their institutions
do not engage in predatory lending. Further, OCC has stated that state
predatory lending laws, rather than reducing predatory lending among
federally supervised institutions, can actually restrict and inhibit legitimate
lending activity. The lending industry has generally supported preemption.
For example, the Mortgage Bankers Association of America has argued
23
Office of Thrift Supervision, P-2003-5, Preemption of New Jersey Predatory Lending Act
(July 22, 2003).
24
Several state law enforcement authorities have also said that predatory lending generally
occurs outside of banks and direct bank subsidiaries. See Brief of Amicus Curiae State
Attorneys General, National Home Equity Mortgage Ass'n v. OTS, Civil Action No. 02-2506
(GK) (D D.C.) (March 21, 2003) at 10-11.
25
For example, see Comments on OCC Working Paper, Center for Responsible Lending,
7-10, October 6, 2003,
http://www.predatorylending.org/pdfs/CRLCommentsonOCCWorkingPaper.pdf.
The Development of a Originators of mortgage loans—which can include banks, other depository
institutions, and mortgage lenders that are not depository institutions—
Secondary Market for may keep the loans or sell them in the secondary market. Secondary
Subprime Loans Can market purchasers may then hold the loans in their own portfolio or may
pool together a group of loans and issue a mortgage-backed security that is
Benefit Consumers backed by a pool of such loans. The securitization of mortgage loans
became common during the 1980s and, by the 1990s, had become a major
source of funding in the prime mortgage market. According to the Office of
Federal Housing Enterprise Oversight, by the end of 2002 more than 58
percent of outstanding U.S. single-family residential mortgage debt was
financed through securitization. Two government-sponsored enterprises—
Fannie Mae and Freddie Mac—represented nearly 40 percent of the
amount securitized.1
1
A government-sponsored enterprise (GSE) is a congressionally chartered, publicly owned
corporation established and accorded favored regulatory treatment to increase access to
the capital market for specific economic sectors, including housing.
Mortgage payments
Borrower takes out loan
and makes mortgage payments
Source: GAO.
Note: This chart represents the process for fully private securitizations and not for government-
sponsored enterprises.
Freddie Mac and Fannie Mae are relatively recent entrants into the
subprime market; Freddie Mac began purchasing subprime loans in 1997
and Fannie Mae in 1999. Both companies have moved slowly and have
limited their purchases to the segment of the subprime market with the
most creditworthy of subprime loans. At present, the companies are
believed to represent a relatively small portion of the overall secondary
market for subprime loans. The exact portion they represent is not clear,
but a study conducted for HUD estimated that the companies purchased
The growth of the secondary market for subprime loans has potentially
benefited some consumers. By providing subprime lenders with a new
source of liquidity, these lenders face lower funding costs and reduced
interest rate risk, in part because the supply of lenders willing to make
loans to borrowers with impaired credit has increased. Many analysts say
that, as a result, mortgage loans are now available to a whole new
population of consumers and interest rates on subprime loans made by
reputable lenders have fallen. In addition, increased securitization of
subprime lending may lead to more uniform underwriting of subprime
loans, which could further reduce origination costs and interest rates to
consumers.
2
K. Temkin, J. Johnson, D. Levy, “Subprime Markets, the Role of GSEs, and Risk-Based
Pricing,” prepared by The Urban Institute for the U.S. Department of Housing and Urban
Development, March 2002. Other estimates of the GSEs’ share of securitization of the
subprime market have varied, in part because—as noted earlier—there is no consistent
industry definition of what constitutes subprime.
3
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 requires
Fannie Mae and Freddie Mac to meet annual percent-of-business housing goals established
by HUD for three categories: low- and moderate-income, underserved, and special
affordable. HUD set the following goals for 2001 through 2003: low- and moderate-income—
50 percent of the total number of units financed; underserved—31 percent of the total
number of units financed; and special affordable—20 percent of the total number of units
financed.
The Secondary Market While the development of a secondary market for subprime loans may have
benefits for borrowers, it can also provide a source of funds for
for Subprime Loans unscrupulous originators that quickly sell off loans with predatory terms.
Can Facilitate The secondary market can complicate efforts to eliminate predatory
lending by separating ownership of a loan from its originator. This
Predatory Lending separation can undermine incentives to reduce risk in lending and create
incentives that may increase the attractiveness of making loans with
predatory terms. As noted earlier, some originators of subprime mortgage
loans make their profits from high origination fees. The existence of a
market that allows originating lenders to quickly resell subprime loans may
reduce the incentive these lenders have to ensure that borrowers can repay.
Further, lenders often market their products through brokers that do not
bear the risks associated with default, as brokers are compensated in up-
front fees for the loans they help originate. Some lenders and state officials
told us that unscrupulous brokers sometimes deceive originating lenders
regarding borrowers’ ability to repay. Even if deceived, lenders who
originate the loans and then sell them in the secondary market ultimately
may not bear the risk of a loan default. Taken together, these
circumstances can undermine efforts to combat predatory lending
practices.
4
Reputation risk is the current and prospective impact on a company’s earnings and capital
arising from negative public opinion from other market participants. This risk may expose a
misbehaving originator or lender to litigation, financial loss, and a decline in its customer
base if its behavior injures its customers or clients.
Due Diligence Can Secondary market purchasers of residential mortgage loans undertake a
process of due diligence designed to minimize legal, financial, and
Help Purchasers Avoid reputation risk associated with the purchase of those loans. Due diligence
Predatory Loans, but can play an important role in avoiding the purchase of abusive loans, but
cannot necessarily identify all potentially abusive loans. Officials of Fannie
Efforts Vary among Mae and Freddie Mac—which, as noted previously, are relatively recent
Secondary Market entrants in the subprime market—are also concerned about risks but say
Participants that their due diligence processes are also designed to avoid purchasing
loans that may have been harmful to consumers. Other firms’ due diligence
is not necessarily specifically intended to avoid loans that may have
harmed consumers but rather to avoid purchasing loans that are not in
compliance with applicable law or that present undue financial or
reputation risks.5
5
OCC has issued guidelines stating that national banks are expected to undertake
appropriate due diligence to avoid purchasing predatory loans. See OCC Advisory Letter
2003-3 (Avoiding Predatory and Abusive Lending Practices in Brokered and Purchased
Loans), February 21, 2003.
Due Diligence May Deter Loans purchased in the secondary market are usually not purchased
the Purchase of Some individually but rather as a pool of many loans. Purchasers or securitizers
of residential mortgage loans try to ensure that the loans in a particular
Predatory Loans but Has pool are creditworthy and in compliance with law. Purchasers perform a
Limitations general background and financial review of the institutions from which
they purchase loans. In addition, secondary market purchasers of loans
nearly always conduct due diligence, or a review and appraisal of
confidential legal and financial information related to the loans themselves.
Before or after the sale, purchasers may review electronic data containing
information on the loans, such as the loan amount, interest rate, and
borrower’s credit score. Purchasers also may physically review a sample of
individual loans, including items such as the loan applications and
settlement forms.
While due diligence in the secondary market is important, the role that it
can play in deterring predatory lending by performing due diligence is
limited. For one thing, more than one-third of all new subprime loans are
not securitized in the first place but are held in the portfolio of the
originating lender and thus do not face securitizers’ due diligence reviews.
In addition, even the most thorough due diligence will not necessarily catch
all abusive loans or abusive lending practices. For example:
• The data tapes used for loan reviews do not include point and fee
information.7 Thus, securitizers typically cannot detect excessive or
unwarranted fees prior to purchasing a loan without a loan-level review.
Fannie Mae and Freddie Fannie Mae and Freddie Mac have relatively strict criteria for the loans
Mac Appear to Perform they purchase, particularly subprime loans. As noted, both companies limit
their purchases to the most creditworthy subprime loans. In April 2000,
Extensive Due Diligence to
Fannie Mae issued guidelines to sellers of subprime loans that set criteria
Avoid Buying Loans with designed to help the GSE avoid purchasing loans with abusive features.
Abusive Terms For example, the guidelines state that Fannie Mae’s approved lenders may
not “steer” a borrower who qualifies for a standard loan to a higher cost
6
Some securitizers have begun to use fraud detection software as part of their due diligence
of residential mortgage loans. Such software analyzes specific data fields within a loan file
and looks for characteristics and inconsistencies that may signal fraud in the appraisal, loan
application, or loan itself. In some cases, a fraud review can also be incorporated as part of
the regular due diligence process.
7
A prepurchase financial due diligence review may not look at point and fee data because
the risks and returns to the loan purchaser depend not on payments that were made at
origination but rather on future payments by the homeowner. However, a review of points
and fees is often done during a subsequent loan-level file review.
product, may not make loans without regard to the borrower’s ability to
repay, and may not in most instances charge more than 5 percent of the
loan amount in points and fees. Freddie Mac issued similar guidelines to its
sellers and servicers in December 2000. Further, both companies, like
other secondary market purchasers, rely on a system of representations
and warranties, under which sellers contractually agree to buy back loans
they sell that turn out not to meet the terms of the contract.
Fannie Mae and Freddie Mac officials told us that they undertake a series
of measures aimed at avoiding the purchase of loans with predatory
characteristics. Approved sellers and servicers undergo a background
check and operational review and assessment that seeks, in part, to
determine whether lenders are able to comply with their guidelines. Fannie
Mae and Freddie Mac also require that special steps, such as additional due
diligence measures, be taken in purchasing subprime loans. For example,
Fannie Mae requires that subprime loans be originated using the company’s
automated desktop underwriting system, which helps ensure that
borrowers are not being steered to a more expensive loan than they qualify
for.8 Fannie Mae officials say that the automated desktop underwriting
system also facilitates traditional lenders that serve subprime borrowers.
In addition, both companies said that they undertake extensive and costly
due diligence that goes well beyond simple legal compliance and is aimed
at avoiding loans that may potentially be considered abusive or detrimental
to the borrower. Both companies use an outside contractor to conduct
their loan-level due diligence reviews on subprime loans. The contractor
has a standard “script” that reviews a large number of data elements related
to legal compliance and creditworthiness. However, the contractor told us
that Fannie Mae and Freddie Mac add elements to the script to make the
review more stringent with regard to identifying potentially abusive
practices. For example, Freddie Mac requires the contractor to check
whether the lender has gathered evidence of a borrower’s income
information directly or relied on self-verification, which can raise
uncertainty about a borrower’s capacity to repay. In addition, the
8
Fannie Mae and Freddie Mac officials note that their antipredatory lending policies and
compliance measures are only one element in their efforts to fight predatory lending. For
example, both companies also have special programs that provide appropriately priced
loans to credit-impaired borrowers and other consumers who tend to be targeted by
predatory lenders; support homebuyer education and counseling for at-risk individuals; and
have special loan programs designed for borrowers who have been targeted or victimized by
predatory lenders.
contractor told us that Fannie Mae and Freddie Mac are more likely than
other firms to reject or require a repurchase if evidence exists that the loan
may involve a predatory practice—even if the loan is otherwise legally
compliant.
Other Purchasers Vary in According to industry representatives, all purchasers of mortgage loans
the Extent of Their Due undertake a process of due diligence, but the process can vary in its degree
of stringency and comprehensiveness. For example, while most firms
Diligence
typically pull a sample of loans for a loan-level file review, companies may
review anywhere between a few percent and 100 percent of the loans. In
addition, companies vary in terms of the data elements they choose to
review. Some firms review prior loans made to the borrower in an effort to
detect loan flipping, while others do not. Further, some companies may be
more willing than others to purchase loans that are considered
questionable in terms of legal compliance, creditworthiness, or other
factors.
As noted earlier, loans that have harmed consumers and that may be
deemed “predatory” by some observers are not necessarily against the law,
nor do they necessarily increase the risk of the loan.9 Industry officials told
us that while securities firms are concerned with the reputation risk that
may come with purchasing abusive loans, the primary function of their due
diligence is to ensure compliance with the law and to protect investors by
ensuring that loans are creditworthy.10
9
One example would be steering borrowers to higher-cost loans than is justified by their
credit histories. This practice is often considered abusive but is not per se a violation of
federal law, nor does it necessarily increase credit risk to the lender.
10
Reputation risk can also be an issue for sellers of loans to the secondary market. Regularly
selling loans that later create risks and costs for secondary market purchasers may close off
the seller’s access to the secondary market.
Assignee Liability May Some states have enacted predatory lending laws that have assignee
liability provisions under which purchasers of secondary market loans may
Help Deter Predatory be liable for violations committed by the originators or subject to a defense
Lending but Can Also by the borrower against collecting the loan. Assignee liability is intended
to discourage secondary market participants from purchasing loans that
Have Negative may have predatory features and to provide an additional source of redress
Unintended for victims of abusive lenders. However, depending on the specific nature
Consequences of the provision, assignee liability may also have unintended consequences,
including reducing access to or increasing the cost of secondary market
capital for legitimate loans. For example, assignee liability provisions of a
predatory lending law in Georgia have been blamed for causing several
participants in the mortgage lending industry to withdraw from the market,
and the provisions were subsequently repealed.
Several States Hold Antipredatory lending laws in several states have included some form of
Secondary Purchasers assignee liability. Typically, with assignee liability, little or no distinction is
made between the broker or lender originating a loan that violates
Liable for Predatory
predatory lending provisions and the person who purchases or securitizes
Lending Violations the loans. Under these provisions, secondary market participants that
acquire loans may be liable for violations of the law committed by the
original lenders or brokers whether or not the purchasers were aware of
the violations at the time they bought the loans. Further, borrowers can
assert the same defenses to foreclosure against both originating lenders
and entities in the secondary market that hold the loans (the assignees).
Depending on the specific provisions of the law, assignees may have to pay
monetary damages to aggrieved borrowers.
As of December 2003, at least nine states and the District of Columbia had
enacted predatory lending laws that expressly included assignee liability
provisions, though the nature of these provisions varies greatly, according
to the database of state and local legislation we reviewed. Other states
have passed predatory lending laws that do not explicitly provide for
assignee liability, but debate has occurred in some of these states about
whether assignee liability can be asserted anyway under existing laws or
legal principles. The federal HOEPA statute includes an assignee liability
provision, but, as noted in chapter 2, only a limited number of subprime
loans are covered under HOEPA.
Assignee liability can take a variety of forms. For example, an assignee can
be held liable only in defensive claims (defense to foreclosure actions and
Assignee Liability May Help The issue of whether to include assignee liability provisions in state and
Combat Predatory Lending local predatory lending laws has been highly controversial, because such
provisions can potentially both confer benefits and cause problems.
but May Also Hinder
Assignee liability has two possible primary benefits. First, holding
Legitimate Lending purchasers and securitizers of loans liable for abusive lending violations
provides them with an incentive not to purchase predatory loans in the first
place. If secondary market participants took greater action—through
policy decisions or stricter due diligence—to avoid purchasing potentially
abusive loans, originators of predatory loans would likely see a steep
decline in their access to secondary market capital. Second, under some
forms of assignee liability, consumers who have been victimized by such
lenders may have an additional source of redress. In some cases,
originators of abusive loans that have been sold in the secondary market
are insolvent or cannot be located, leaving victims dependent on assignees
for relief from foreclosure or other redress.
11
Under New York’s law, an assignee seeking to enforce a loan against a borrower in default
or in foreclosure is subject to the borrower’s claims and defenses to payment that the
borrower could assert against the original lender. See NY Banking Law § 6-l (2003). Under
Maine’s law, an assignee may be subject to all claims and defenses that the borrower may
assert against the creditor of the mortgage. See Maine Rev. Stat. Ann. Title 9-A § 8-209
(2003).
12
See, e.g., N.J. Stat. Ann. § 46:10B-27 (West 2003); see also, 815 Ill. Comp. Stat. 137/135
(2003).
Credit rating agencies have been among the secondary market players that
have expressed concern about assignee liability provisions in state
predatory lending laws. When a residential mortgage-backed security is
created from a pool of loans, an independent credit rating agency examines
the security’s underlying loans and assigns it with a credit rating, which
represents an opinion of its general creditworthiness. Credit rating
agencies need to monetize (measure) the risk associated with the loans
underlying a security in order to assign a credit rating. Because assignee
liability can create additional legal and financial risks, the major credit
rating agencies typically review new predatory lending legislation to assess
whether they will be able to measure that risk adequately to rate securities
backed by loans covered under the law.
Georgia’s Statute Illustrates According to officials of industry and consumer advocacy organizations,
Possible Effects of Assignee the Georgia Fair Lending Act, which became effective on October 1, 2002,
was one of the strictest antipredatory lending laws in the nation.14 It
Liability Provisions
banned single-premium credit insurance and set restrictions on late fees for
all mortgage loans originated in the state and, for a special category of
“covered loans,” prohibited refinancing within 5 years after consummation
of an existing home loan unless the new loan provided a “tangible net
benefit” to the borrower. The act also created a category of “high-cost
loans” that were subject to certain restrictions, including limitations on
prepayment penalties, prohibitions on balloon payments, and prohibitions
on loans that were made without regard to the borrower’s ability to repay.
13
City of Toledo Ordinance No. 291-02 (Oct. 4, 2002).
14
The Georgia Fair Lending Act is codified at GA Code Ann. §§ 7-6A-1 et. seq. OTS, NCUA,
and OCC have determined that the Georgia law does not apply to the institutions they
supervise because it is preempted by federal law. See Office of Thrift Supervision, P-2003-1,
Preemption of Georgia Fair Lending Act (Jan. 21, 2003); National Credit Union
Administration, 02-0649, Applicability of Georgia Fair Lending Act to Federal Credit Unions
(July 29, 2002); National Credit Union Administration, 03-0412, NCUA Preemption of the
Georgia Fair Lending Act (Nov. 10, 2003); and OCC Preemption Determination and Order,
Docket No. 03-17 (July 30, 2003). Because Georgia law contains a parity provision under
which its state-chartered banks are treated similarly to national banks, Georgia’s
Commissioner of Banking and Finance ruled that Georgia-chartered banks also are not
subject to the Fair Lending Act. See Declaratory Ruling: Effect of Preemption of Georgia
Fair Lending Act by the OCC on July 30, 2003 (Aug. 5, 2003).
The act also included fairly strict assignee liability. Secondary market
participants that purchased high-cost loans were liable for violations of the
law committed by the originator of the loans they purchased, while
purchasers of covered loans were subject to borrower defenses and
counterclaims based on violations of the act. The act also expressly made
mortgage brokers and loan servicers liable for violations. Remedies
available to borrowers included actual damages, rescission of high-cost
loans, attorney fees, and punitive damages. Most of the violations were
civil offenses, but knowing violations constituted criminal offenses.
Shortly after the Georgia Fair Lending Act took effect, several mortgage
lenders announced that they would stop doing business in the state due to
the increased risk they would incur. In addition, several secondary market
participants stated their intention to cease doing business in Georgia. In
January 2003, the credit rating agency Standard & Poor’s announced it
would stop rating mortgage-backed securities in Georgia because of the
uncertainty surrounding potential liability under the act. Standard & Poor’s
decision extended to securitizations of virtually all loans in the state, not
just those of covered or high-cost loans. The company said that because
the act did not provide an unambiguous definition of which loans were
covered (and therefore subject to assignee liability), it could not adequately
assess the potential risk to securitizers. In addition, the company said that
it was concerned about an antiflipping provision that did not adequately
define what constituted the “net tangible benefit” to borrowers that certain
refinancings had to provide. The two other major credit rating agencies,
Moody’s and Fitch, also said that the law would limit their ability to rate
mortgage-backed securities in Georgia.
activists said that Standard & Poor’s and others had engaged in an
orchestrated effort to roll back the Georgia Fair Lending Act. Industry
representatives said that the response by lenders and others was a
reasonable response to a statute that created unacceptable risks of legal
liability for lenders and assignees.
Many Consumer In response to widespread concern about low levels of financial literacy
among consumers, federal agencies such as FDIC, HUD, and OTS have
Education and conducted and funded initiatives designed in part to raise consumers’
Mortgage Counseling awareness of predatory lending practices. In addition, a number of states,
nonprofits, and trade organizations have undertaken consumer education
Efforts Exist, but initiatives. Prepurchase mortgage counseling—which can include a third
Several Factors Limit party review of a prospective mortgage loan—may also help borrowers
Their Potential to avoid predatory loans, in part by alerting them to the characteristics of
predatory loans. In some circumstances, such counseling is required.
Deter Predatory However, a variety of factors limit the potential of these tools to deter
Lending predatory lending practices.
Some Federal Agencies A number of federal agencies and industry trade groups have advocated
Have Initiatives to Promote financial education for consumers as a means of improving consumers’
financial literacy and addressing predatory lending. The Department of the
Awareness of Predatory Treasury, as well as consumer and industry groups, have identified the lack
Lending of financial literacy in the United States as a serious, widespread problem.1
Studies have shown that many Americans lack a basic knowledge and
understanding of how to manage money, use debt responsibly, and make
wise financial decisions.2 As a result, some federal agencies have
conducted or funded programs and initiatives that serve to educate and
inform consumers about personal financial matters. For example:
1
The Fair and Accurate Credit Transactions Act of 2003 (Pub. L. No. 108-159), which was
enacted on December 4, 2003, addresses financial literacy in a number of its provisions.
Among other things, it establishes a financial literacy and education commission consisting
of representatives of FTC, the federal banking regulators, HUD, the Department of the
Treasury, and other federal agencies.
2
See National Endowment for Financial Education, “Financial Literacy in America:
Individual Choices, National Consequences,” report based on the symposium “The State of
Financial Literacy in America: Evolutions and Revolutions,” October 2002 (Greenwood
Village, Colorado, 2002), 1 and 6; Maude Toussaint-Comeau and Sherrie L.W. Rhine,
“Delivery of Financial Literacy Programs,” Policy Studies, Consumer Issues Research
Series, Consumer and Community Affairs Division, Federal Reserve Bank of Chicago (2000),
1; Marianne A. Hilgert, Jeanne M. Hogarth, and Sondra Beverly, “Household Financial
Management: The Connection between Knowledge and Behavior,” Federal Reserve Bulletin,
July 2003, 309 and 311.
3
OCC Advisory Letter 2001-1, Financial Literacy, January 16, 2001.
State Agencies, Nonprofits, Some state agencies have also sponsored consumer education initiatives
and Industry Organizations that address predatory lending. For example, the Connecticut Department
of Banking offers an educational program in both English and Spanish that
Have Also Initiated partners with neighborhood assistance groups and others to promote
Consumer Education financial literacy and educate consumers on the state’s antipredatory
Efforts lending statute. The Massachusetts Division of Banks maintains a toll-free
mortgage hotline to assist homeowners about potentially unethical and
unlawful lending practices. The hotline helps consumers determine
whether loan terms may be predatory and directs them to other sources of
information and assistance. The New York State Banking Department
distributes educational materials, including a video, that describe
predatory lending practices. The department has also conducted
educational outreach programs to community groups on the issue.
• Fannie Mae supports financial literacy programs through its Fannie Mae
Foundation, which sponsors homeownership education programs that
focus on improving financial skills and literacy for adult students and at-
risk populations, such as new Americans and Native Americans. Fannie
Mae also offers a Web-based tool that allows home-buyers to compare
loan products and prices.
Mortgage Counseling Can Mortgage counseling can be part of general “homeownership counseling”
Warn Borrowers of for new homeowners but may also be offered prior to a refinancing. It
gives borrowers an opportunity to receive personalized advice from a
Predatory Lending and Can
disinterested third party about a proposed mortgage or other loan. In
Offer a “Third Party” Review addition to providing general advice about the mortgage process and loan
of Proposed Mortgage products, counselors typically review the terms of proposed loans for
Loans potentially predatory characteristics. Studies evaluating the impact of
homeownership counseling have found that it helps homeowners maintain
ownership of their homes and avoid delinquencies, particularly when the
counseling is provided one on one.4 HUD supports a network of
approximately 1,700 approved counseling agencies across the country. The
agencies provide a wide variety of education and counseling services,
including homebuyer education and prepurchase counseling. HUD makes
grant funds available to some of these agencies, and a portion of these
funds has been earmarked exclusively for counseling for victims of
predatory lending.
4
See, for example, Abdighani Hirad and Peter M. Zorn, “A Little Knowledge is a Good Thing:
Empirical Evidence of the Effectiveness of Pre-Purchase Homeownership Counseling,” in
Low-Income Homeownership: Examining the Unexamined Goal, ed. Nicolas P. Retsinas
and Eric S. Belsky (Washington, D.C.: Brookings Institution Press and Harvard University
Joint Center on Housing Studies, 2001), 2.
A Variety of Factors May In testimony before Congress and elsewhere, representatives of the
Limit the Effectiveness of Mortgage Bankers Association, the Consumer Mortgage Coalition, and
other industry organizations have promoted the view that educated
Consumer Education and borrowers are more likely to shop around for beneficial loan terms and
Mortgage Counseling in avoid abusive lending practices. In searching the literature for studies on
Deterring Predatory the effectiveness of consumer financial education programs, we found
Lending evidence that financial literacy programs may produce positive changes in
consumers’ financial behavior.5 However, none of the studies measured the
effectiveness of consumer information campaigns specifically on deterring
predatory lending practices.
Limitations of Consumer The majority of federal officials and consumer advocates we contacted said
Education that while consumer education can be very useful, it is unlikely to play a
substantial role in reducing the incidence of predatory lending practices,
for several reasons:
• Third, the consumers who are often the targets of predatory lenders are
also some of the hardest to reach with educational information. Victims
of predatory lending are often not highly educated or literate and may
5
See for example, B. Douglas Mernheim, Daniel M. Garrett, and Dean M. Maki, Education
and Saving: The Long-Term Effects of High School Financial Curriculum Mandates
(Cambridge, Mass.: National Bureau of Economic Research, 1997), 29-30.
not read or speak English. Further, they may lack access to information
conveyed through the Internet or traditional banking sources, or they
may have hearing or visual impairments or mobility problems.
Although some states have mandated counseling for certain types of loans,
serious practical barriers would exist to instituting mandatory prepurchase
mortgage counseling nationally. HUD officials have noted that instituting a
mandatory counseling program for most regular mortgage transactions
nationwide would be an enormous and difficult undertaking that might not
6
For example, TILA requires federal lenders to make certain disclosures on mortgage loans
within 3 business days after the receipt of a written application. It also requires a final
disclosure statement at the time of closing that includes the contract sales price, principal
amount of the new loan, interest rate, broker’s commission, loan origination fee, and
mortgage and hazard insurance, among other things.
HUD requires counseling for its reverse mortgages. These mortgages allow
homeowners to access the equity in their home through a lender, who
makes payments to the owner.7 Borrowers who receive a home equity
conversion mortgage insured through FHA must attend a consumer
information session given by a HUD-approved housing counselor.
Mandatory counseling for reverse mortgages may be reasonable because
these products are complex and subject to abuse. However, reverse
mortgages are also relatively uncommon; only approximately 17,610 HUD-
insured reverse mortgages were originated in fiscal year 2003.
7
The loan is not repaid in full until the homeowner permanently moves out of the home,
passes away, or other specified events have occurred.
8
Board of Governors of the Federal Reserve System and the Department of Housing and
Urban Development, Joint Report to the Congress Concerning Reform to the Truth In
Lending Act and the Real Estate Settlement Procedures Act (Washington, D.C.: July 1998).
9
See 67 Fed. Reg. 49134 (Jul. 29, 2002).
A Number of Factors Nearly all federal, state, and consumer advocacy officials with whom we
spoke offered consistent observational and anecdotal information that
Make Elderly elderly consumers have disproportionately been victims of predatory
Consumers Targets of lending. Little hard data exist on the ages of victims of predatory lending or
on the proportion of victims who are elderly. Nonetheless, several factors
Predatory Lenders explain why unscrupulous lenders may target older consumers and why
some elderly homeowners may be more vulnerable to abusive lenders,
including higher home equity, a greater need for cash to supplement limited
incomes, and a greater likelihood of physical impairments, diminished
cognitive abilities, and social isolation.
1
No clear agreement exists on the age at which someone is considered “elderly.” While we
do not designate any specific age in this report with reference to the terms “older” or
“elderly,” we are generally referring to persons over the age of 65.
2
For example, a study by the Board found that in 1997, some 55 percent of the homeowners
who had fully paid off their mortgage were 65 years of age or older. See Glenn B. Canner,
Thomas A. Durkin, and Charles A. Luckett, “Recent Developments in Home Equity Lending,”
Federal Reserve Bulletin, April 1998, 241-51. Borrowers may have substantial equity in their
homes but still not qualify for a prime loan because their capacity to repay the loan is limited
or their credit score is beneath a certain threshold.
of the home equity loan.3 Federal officials and consumer groups say that
abusive lenders often try to convince elderly borrowers to repeatedly
refinance their loans, adding more costs each time. “Flipping” loans in this
way can over time literally wipe out owners’ equity in their homes.
Similarly, while many older persons enjoy excellent mental and cognitive
capacity, others experience the diminished cognitive capacity and
judgment that sometimes occurs with advanced age. Age-related
dementias or mental impairments can limit the capacity of some older
persons to comprehend and make informed judgments on financial issues,
according to an expert in behavioral medicine at the National Institute on
Aging. Furthermore, a report sponsored by the National Academy of
Sciences on the mistreatment of elderly persons reported that they may be
more likely to have conditions or disabilities that make them easy targets
for financial abuse and they may have diminished capacity to evaluate
proposed courses of action. The report noted that these impairments can
3
For example, a loan might be offered to a borrower who owns a home worth $100,000 and
owes $20,000 from a previous mortgage. An abusive lender might refinance the loan for
$25,000 (providing the borrower with a $5,000 “cashout”) but then charge fees of $15,000,
which are financed into the loan. The borrower then would owe $40,000, but might not be
aware of the excessive fees that were charged because the monthly repayment schedule had
been spread over a much longer period of time.
Federal officials, legal aid services, and consumer groups have reported
that home repair scams targeting elderly homeowners are particularly
common. Elderly homeowners often live in older homes and are more
likely to need someone to do repairs for them. The HUD-Treasury report
noted that predatory brokers and home improvement contractors have
collaborated to swindle older consumers. A contractor may come to a
homeowner’s door, pressure the homeowner into accepting a home
improvement contract, and arrange for financing of the work with a high-
cost loan. The contractor then does shoddy work or does not finish the
agreed-on repairs, leaving the borrower to pay off the expensive loan.
4
Richard J. Bonnie and Robert B. Wallace, eds., “Elder Mistreatment: Abuse, Neglect, and
Exploitation in an Aging America,” Panel to Review Risk and Prevalence of Elder Abuse and
Neglect, National Research Council (Washington, D.C.: National Academies Press, 2003),
393.
Some Education and Because elderly people appear to be more susceptible to predatory lending,
government agencies and consumer advocacy organizations have focused
Enforcement Efforts some educational efforts and legal assistance on this population. Several
Focus on Elderly booklets, pamphlets, and seminars are aimed at helping inform elderly
borrowers about predatory lending. In addition, while most legal activities
Consumers related to predatory lending practices are designed to assist the general
population of consumers, some have focused on elderly consumers in
particular.
Federal and Nonprofit Consumer financial education efforts of government and nonprofit
Agencies Sponsor Some agencies and industry associations generally seek to serve the general
consumer population rather than target specific subpopulations. However,
Financial Education Efforts some federal and nonprofit agencies have made efforts to increase
Targeted at Older awareness about predatory lending specifically among older consumers.
Consumers For example:
5
For example, about 25 percent of elderly black Americans had graduated from high school
in 1992, compared with about 58 percent of elderly white Americans, and about 57 percent
of elderly black Americans were reported to have had fewer than 9 years of formal
education. See Robert Joseph Taylor and Shirley A. Lockery, “Socio-Economic Status of
Older Black Americans: Education, Income, Poverty, Political Participation and Religious
Involvement,” African American Research Perspectives 2 (1): 3-4.
Some Legal Assistance Is Federal consumer protection and fair lending laws that have been used to
Aimed Specifically at address predatory lending do not generally have provisions specific to
elderly persons. For example, age is not a protected class under the Fair
Helping Older Victims of
Housing Act, which prohibits discrimination in housing-related
Predatory Lending transactions. In addition, HMDA—which requires certain financial
• The National Consumer Law Center has a “Seniors Initiative” that seeks
to improve the quality and accessibility of legal assistance with
consumer issues for vulnerable older Americans. One focus of the
initiative is preventing abusive lending and foreclosure. The center
publishes a guide for legal advocates to help them pursue predatory
lending cases, and has been involved in litigation related to cases of
predatory lending against senior citizens.
• Some local legal aid organizations that help victims of predatory lending
have traditionally served older clients. For example, the majority of
clients assisted by South Brooklyn Legal Services’ Foreclosure
Prevention Project are senior citizens.
Primary defendant Date of settlementa Federal laws cited Alleged unfair or deceptive practices
Capital City Mortgage (litigation ongoing) FTC Act, TILA, ECOA, Fair Using deception/misrepresentation to manipulate
Corporationb Debt Collection Practices borrowers into loans, ECOA recordkeeping and
Act notice violations, unfair and deceptive loan
servicing violations
OSI Financial Services, November 2003 FTC Act Using deception/misrepresentation to charge
Inc., and Mark Diamondc excessive loan fees
First Alliance Mortgage March 2002 FTC Act, TILA Using deception/misrepresentation to charge
Companyd excessive loan fees
Associates First Capital September 2002 FTC Act, TILA, ECOA, Using deception/misrepresentation to manipulate
Corporation, Associates FCRA borrowers into loans, packing undisclosed
Corporation of North products (insurance) into loans, unfair debt
America, Citigroup Inc., and collection
CitiFinancial Credit
Company
Mercantile Mortgage July 2002 FTC Act, TILA, HOEPA, Using deception/misrepresentation to manipulate
Company, Inc.e RESPA, Credit Practices borrowers into loans, illegal kickbacks, HOEPA
Rule disclosure violations, taking unlawful security
interests
Action Loan Company, Inc.f August 2000 FTC Act, TILA, RESPA, Packing undisclosed products (insurance) into
Credit Practices Rule, loans, kickbacks for the referral of loans, ECOA
ECOA, FCRA violation for failing to meet requirements upon
adverse actions, taking unlawful security interest
FirstPlus Financial Group, August 2000 FTC Act, TILA Using deception/misrepresentation to manipulate
Inc. borrowers into home equity loans, TILA
disclosure violations
Nu West, Inc. July 2000 FTC Act, TILA, HOEPA HOEPA disclosure violations, right of rescission
violations
Delta Funding Corporation March 2000 HOEPA, RESPA, ECOA, Pattern or practice of asset-based lending and
and Delta Financial Fair Housing Act other HOEPA violations, paying kickbacks and
Corporationg unearned fees to brokers, intentionally charging
African American females higher loan prices than
similarly situated white males
Fleet Finance, Inc. and October 1999 FTC Act, TILA Failure to provide, or provide accurately, (1) timely
Home Equity USA, Inc. disclosures of the costs and terms of home equity
loans and/or (2) information to consumers about
their rights to cancel their credit transactions
Barry Cooper Properties July 1999 FTC Act, HOEPA Pattern or practice of asset-based lending and
other HOEPA violations
Capitol Mortgage July 1999 FTC Act, TILA, HOEPA HOEPA disclosure violations, right of rescission
Corporation violations
CLS Financial Services, July 1999 FTC Act, HOEPA Pattern or practice of asset-based lending and
Inc. other HOEPA violations
Granite Mortgage, LLC and July 1999 FTC Act, TILA, HOEPA Pattern or practice of asset-based lending and
others other HOEPA violations
Note: In addition to the cases listed, FTC has also recently addressed abuses in the mortgage loan
servicing industry. In November 2003, it announced settlements with Fairbanks Capital Holding Corp.,
its wholly owned subsidiary Fairbanks Capital Corp., and their founder and former CEO (collectively,
Fairbanks) on charges that Fairbanks violated the FTC Act, RESPA, and other laws by failing to post
consumers’ mortgage payments in a timely manner and charging consumers illegal late fees and other
unauthorized fees. The settlement will provide for $40 million in redress to consumers. The case was
jointly filed with HUD. United States of America v. Fairbanks Capital Corp. et al., Civ. Action No. 03-
12219-DPW (D. Mass.)(filed 11/12/03).
a
In some cases, the date of settlement listed is the date of the press release announcing the
settlement.
b
DOJ filed an amicus curiae brief in a private suit alleging discrimination in violation of the ECOA and
Fair Housing Act, which was joined with the FTC case, but settled separately.
c
The state of Illinois was also a plaintiff in this case.
d
The states of Arizona, California, Massachusetts, Florida, New York, Illinois, AARP, and private
attorneys were also plaintiffs in this case.
e
HUD and the state of Illinois were also plaintiffs in this case. Violations of Illinois state law were also
claimed.
f
HUD was also a plaintiff in this case, and DOJ formally filed the complaint on behalf of FTC and HUD.
g
DOJ and HUD were also plaintiffs in this case.
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